Order Flow - Achieving the mindset

I for one, believe that they do work together... this may be contrary to others belief's about the structure of the FX market.

Your either laughing at my flawed logic (which would not surprise me), or your being serious.

If your laughing at me, I'll laugh along with you, I am still trying to grasp some of these simple concepts but man I'm struggling!

If your really think your too dumb, knock it off! Keep posting!

How do you know they are ever on the wrong side of the market. For Example, In T&E page 283,"Dealers who hold no inventory avoid the costs of financing there positions, they do not lose when prices move against them." Now let me explain my logic and it may be off. On page 285 in T&E it talks about Diversifiable inventory risk, dealers can control there inventory risk by dealing in many instruments. So if everyone is selling usd and buying euro then they would most likely offset the risk by the flows of money in the euro against the pound and all other currencies. Maybe there bid ask are all the same and they are just competing for more business to make the money on the spread. I may be way off. So if the dealer had there basket of currencies evenly distributed than the risk would be off set and then they would be making money also off the 90 percent losers if that statistic is correct. I am sure some of the big guns will straighten me out if I am way out in left field.

I don't have an answer for you. I am thinking this is going to take a long time to get to a point of understanding.

There are many possibilities... These are some things i started to think about...

Here is just one hypothetical situation to think about:

A dealer has a balanced book, price is increasing, 20 pips above the current price he has $1 billion worth of pending buy stops on his books. Here are his options (let me know if you can think of more options):

-Wait and see if price hits the stops and be short $1 billion...
-Try to sell the market down to prevent the stops being hit and risk being
short even more than $1 billion...
-Start to lay off some of the orders with other banks/dealers as it approaches...

In the above situation, if he chooses not to cover or if if price shoots up 50 pips really quickly before he has a chance to cover sufficiently, or if there is not sufficient liquidity to cover... Should he take the hit and cover at a worse price or just hope price comes back? what happens to the market if he takes the hit? etc etc

Guys, if you want to know how fx dealers work, rather than just guessing read Osler and Lyons, and other papers that deal with how fx dealers manage inventory (there are a good number of them if you search). T&E is good generically but not enough if you're interested specifically in fx dealers.

A forex dealer is just a trader/broker with deeper pockets.
It is nearly impossible to grab the spread from every transaction because of the huge competition.
Soon or later he automatically builds inventory that can be
a) hedged or protected with options or through derivatives
b) unloaded on client orders
c) unloading on the interbank market
for profits.

But the most part is pure speculation.

An analogy from another market is: Nick Leeson.
He was a dealer.

Here an old article about interbank dealer which gives you a quick view:
http://www.independent.co.uk/news/uk...t-1554010.html

Thanks euro I'll check that out when I'm finished with T&E. And thanks UP for the nice link.

Right now I feel like the thread is taking another course and we seem to talk about other things (I know OF is a big thing and includes several stuff) but there is one thing I really really want to talk about which I think would benefit all learners.

It's about HOW price moves.
When I understood the concept of order flow mentality I understood WHY it moved. Because there came news or anything regarding the currency people start buying/selling and one tries to predict at which way most orders will generate. That's the why. The how, I still don't know.

I have seen people talking about liquidity consumption and price discovery process but haven't had anything 'fitted' into my brain.
So my question to you all is (and also what I want to discuss):
How does prices move?

Take care lads, hope you don't think I'm dictatorial on the thread.. if so then never mind what I wrote here. I just felt it would be the next step after understanding the mentality.

Thanks eurotrash and unnamed.

I KNOW WHAT YOU ARE TALKING ABOUT!!!!! (I think)

If you say that it is too many participants and infinite numbers of "plays". Then the only way game theory can be applied in this is with outcome and probability of the outcome!!

Am I right Darkstar? If so it's a breakthrough!!
Please someone help me out here!

For me understanding how interbank dealers deal seems like a very important piece to understanding the much larger question "how does price move". So I am going to continue on that route for now offline.

Hey again guys,

I've been meaning to write my foundational microstructure thoughts out somewhere, and now that Carnegie has asked for some input, it seems like a fitting occasion to get them into writing.

The following is my mental construct of price movement, which is liable to flaws and should be taken with a grain of salt. Constructive criticism is anticipated and will be embraced.

Here goes.

A market in the broadest sense of the word, represents a venue (not necessarily physical) which facilitates trade in a good, service or financial instrument (for brevity let's just broadly group all of the above as instruments), buy bringing buyers and sellers into contact to enable them to conduct transactions.

From a microstructure standpoint, our focus gravitates towards two prices:

 

1. The Bid: This is the best (highest) current price at which participants are willing to buy the instrument.
2. The Ask: This represents the best (lowest) current price at which participants are willing to sell the instrument.

Participants will not want to sell for a lower price than they can buy at, and conversely they will not want to buy at a higher price than they can sell. This leads to a small gap in between the bid and the ask, called the spread. The market is defined as being bound by the bid and the ask.

But how can participants let it be known that they are willing to buy and sell at given prices? This is done through the issuance of limit orders. This disclosure of participants of their willingness to trade at particular prices, constitutes liquidity. Liquidity can be thought of as the concentration of limit orders at a particular price or price region. When liquidity is described as high or deep, it means that several limit orders exist at a particular price or price region, waiting to be executed. Conversely, when liquidity is described as thin or low, it means that the concentration of limit orders at a particular price or price region is lacking.

Liquidity is important in financial markets, because it enables participants to conduct transactions of size quickly and efficiently, allowing them to have their order filled as close to their desired value as possible. Liquidity is the parameter which allows for the possibility of identically sized orders to have significantly different impacts on price.

Thus we see that liquidity, issued in the form of limit orders provides a sort of framework to the market, by communicating prices at which individuals are willing to buy and sell. Limit orders will be either buy limits, the best one being the bid, and progressively lower ones accumulating behind it; or sell limits, the best one being the ask and progressively higher ones accumulating behind it.

Limit orders however can only be satisfied via the issuance of market orders. A buy market order executes at the ask, and a sell market order executes at the bid.

MARKET ORDERS AND LIMIT ORDERS ARE ESSENTIALLY THE TWO FUNDAMENTAL ORDER TYPES WHICH DRIVE MARKETS. All other order-types are more or less modifications of them.

Imagine the following ask region in a fictitious market:

Jane - 200 contracts - 1.4000
Mike - 200 contracts - 1.4000
Sue - 600 contracts - 1.3500
Ron - 300 contracts - 1.3000

The first thing to notice is that participants can issue limit orders at the same price, and the orders will be filled in the priority in which they were issued by the participants. Thus Mike's contracts will be sold before Jane's since he issued the orders before Jane, even though they are at the same price.

Secondly the only way Mike's contracts can be sold, is if he waits for all of Ron's contracts followed by Sue's contracts to sell, or if he removes his order and relists it at 1.2999.

John comes along and desires to purchase 1000 contracts of the instrument. The ask is 1.3000 when he executes his buy market order to do so. He will first consume all the liquidity provided by Ron (300 contracts) at 1.3000, causing the ask to now become 1.3500. He will then consume all the liquidity provided by Sue (600 contracts) at 1.3500, causing the ask to now become 1.4000. He will then consume 100 of Mike's contracts at 1.4000 to complete his order, leaving 100 of Mike's contracts on the market, and thus the ask remains at 1.4000. Thus the instrument moved from being sold at 1.3000 to now being sold at 1.4000.

[NOTE HOW MIKE'S ORDER HAD TO BE SPREAD OUT AND HIS AVERAGE FILL ENDED UP BEING MUCH GREATER THAN THE 1.3000 HE ANTICIPATED. THIS EMPHASIZES WHY AREAS OF LIQUIDITY ARE PARTICULARLY IMPORTANT TO PARTICIPANTS OF SIZE]

Participants may then issue new limit orders ahead of Mike, if they desire quicker execution, and do not want to sell all the way at the bid, which is let's say 1.2000. This would result in the ask being brought back down.

However, when there is buying pressure to the upside (ie. sell limit orders are being consumed), we will often see new buy limits being issued as the ask moves up, and thus the bid would appear to follow the ask. Sellers seeing prices moving upwards, would be tempted to sell for more, and buyers would be willing to buy at these higher prices, knowing that they can sell for more. Price in general, would thus be rising. The opposite scenario also holds when price is falling.

You have to be able to superimpose the constant addition and removal of limit orders on the actual execution of orders, to be able to accurately envision what I'm talking about. I know you have seen the D.O.M recently Carnegie, so I'm hoping this would be a bit easier for you to grasp. However the D.O.M will not show you whether movement in the bid/ask was due to the execution of orders or whether it was due to removal of limit buys/sells; removal of liqudiity. Both of these will cause movements in price, if the latter represent the bid or the ask.

To distinguish between the two, we would have to use what is known as "Time and Sales".

As shown in the simplified example, different individuals will have different interpretations as to the 'perceived value' of the instrument, leading to a liquidity distribution which approximates the diagram which Darkstar uploaded for us in the other thread. This is because participants will want to buy low, when the instrument is undervalued and sell high, when the instrument is overvalued.

I know the explanation may be rushed and I may be leaving out a few key elements, but I've tried to compress it to a nutshell because I have other obligations to attend to. In my opinion, the three important thing I was able to grasp from understanding microstructure were:

1. The effect hitting stop-losses would have on price
2. The effect a large order hitting the market would have on price and the underlying liquidity distribution
3. The effect a large chunk or liquidity would have on price

Hope this may help you in any way possible,

Regards,
xXTrizzleXx

Price moves usually when active buyers overcome supply (offer size).

That was from a prog.But he mixed the colors,they should have been inverted (bid:green / offer:red).


http://img251.imageshack.us/img251/1...upplydepth.png

You can use Bayesian Equilibrium for the outcome of the game scenario, but thats a later stage problem.

Before you can solve the game you need to define the scenario. Who are the participants? What are their objectives? What strategies are they using? How much of the global information set do they have access to?

Inductive inference is the mechanism you use to establish the answers to these questions.

Could we just split the participants in Informed big players, Informed players, Uninformed big players and Uninformed players?

And we all know that the big players need liquidity to enter the market, and stop hunting is a way to find the needed liquidity.
Is there another method they use to find liquidity?

I guess the main objective is to speculate, but there are also hedging participants and others.
http://www.forexfactory.com/showpost...&postcount=443
Is that complete? or there are missing pieces?

Once we know every participant, they way they play and what are their intentions (and most of that info is available), we need to know WHEN they are willing play, that's the main problem.

They could 'trick' other participents into the market by manufacturing false break-outs? False reversal signals?

Can't they also trigger certain types of options by pushing price to certain levels?

I'm getting a bit of an impression that you guys think the fx market is only comprised of traders and/or people trying to make a short term profit from their dealings. And that its all a bit of a cloak and dagger game.

I'm not fully convinced that it is and neither am I fully convinced you can split players into 'informed' and 'uninformed' categories. Everyone is on a continuum with each participant having a continuously changing degree of 'informedness'.

I also think there are too many that believe those working for big institutions actually know what they're doing. I don't believe that is the case all the time. Huge mistakes are made every day. Wrong shots called and large amounts lost on a daily basis by those who are considered to be 'informed'.

Also, one needs to take into consideration time perspectives with each participant having a different time perspective.

And randomness. Who can predict a major importer/exporter requiring a huge currency deal to satisfy a new order ?

I like the idea of analysing order flow but I think this thread has lost its way a little. And I'm very happy to learn from those with practical experience of order flow analysis.

Here are just a few places they may find liquidity:

Taking the opposite side of a trend. (technical or fundamental)

Taking the opposite side of a News event.

In a range.

Say they were Buying a Down Trend and have stopped it falling, the next trick they need to preform is to get price to rise but not cost them a lot to do it.

Here is one way, try and buy price up during low volume hours.

Any one what to think out loud how they might also achieve it.

.

Hmm.. don't know how to say this but, is it just more or is this FXNews (including IFR) the biggest shit you've ever seen?

There is no info WHAT SO EVER about flows or anything, just "summary EUR/CHF trader" trader or "summary EURUSD trader" and some bullshit about where the daily high/low was and other bullshit like price approaching 200 EMA. If I wanted that I would just plot out 200 ema on the chart wouldn't I!?

Does anyone know any good FX news service? I kinda like fxlive.. but they're a little slow.

Take care, hope we can spark a discussion about news services atleast...

you want to watch the IFR forexwatch and orders board and options stuff... I filter out the rest.