Trading or investing in the stock market without analysis is like gambling,it’s not sure you will earn a profit, even there are equal chances of losses. You can use fundamental analysis or technical analysis to analyse the market and individual stocks as per your investing perspective or trading strategy. Some of the traders are now also using sentiment analysis and other techniques to analyse the market to make better trade decisions.

Order flow analysis is another trading strategy you can use to analyse the market and trading activities based on the orders placed in the market. Here we are going to discuss order flow trading, how you can identify order flow in trading, and how you can use the order flow in trading with the right analysis and trading strategies in the stock market.

What is Order Flow in Trading?

Order flow in the stock market trading is a type of trading strategy used by traders. In this strategy, traders analyse the flow of buy and sell orders placed by the traders in the market. You can watch the order book or footprint chart using the market depth.

The order flow analysis will help you to see what types of orders are being placed at certain points of time in the market. Based on these orders, how the price of the underlying security is affected? You can check or analyse the Buy and Sell orders at a given price point for any segment including, equity cash, future and options or in any other market.

Also Read: Types of Orders in Option Trading in Algo with Order Placement Tips

Sometimes this is used as a short-term trading strategy to enter into the trade positions based on the order flow in the market. For example, a significant number of buy orders at a specific price level shows the strong demand at this level will push the price of the security if sell orders are not able to meet the demand of buy orders.

On the other hand, an abundance of sell orders at a particular price at a point in time can lead to a decrease in the price of the security if the number of buy orders is not able to meet the sell orders. Hence, identifying this gap or analysing the flow or order at the right point of time is very important to make the best use of this strategy in trading.

How do you Read or Identify Order Flow in Trading?

To read or identify the order flow in trading you need the latest and live data of top orders with the volume of trades and transactions. And to gather all these data you can use the depth of market for the top five orders with their buy and sell or bid and ask details.

Similarly, you can use the footprint graphs to see the volume of trading at each price level. While to identify the individual trades made in the market you can use the time and sales data. The time and sales date will show you the price, volume, and time of each transaction.

Apart from this you also need to use the market profile that shows the distribution of trading volumeat the different price levels for a given time period and it should be in graphical format. This is called the market profile which will provide you with the data in a graphical format to analyse the order flow in the market for a particular security at the given point of time.

How to Use Order Flow in Trading?

To apply the order flows trading you have to use various indicators and tools that will help you to understand the low of orders in the market and how it is affecting the market movement. The order flow consists of price, time and volume factors that you need to consider in combination. Missing any one of them will not give you the true picture of order flow.

Order Flow Trading Indicators or Tools

Depth of Market: Depth of Market or DOM provides the in-depth details of all buy and sell orders at various price levels placed in the market. Here you can see all the bids and ask orders with their quantities and prices disclosed by the exchange in the order book. DOM contains the most basic order book showing the limit orders along with the quantity at each price.

And using the level 2 depth of market, you can get to know the market liquidity and transparency that will help you to understand the current demand and supply in the market. DOM will also help you to know the likelihood of order execution at certain levels with the potential support and resistance zones based on volume addition at particular prices.

Time and Sales: This useful indicator will provide you with the record of individual trades executed in the market with their prices, volume and time of each transaction. It gives real-time data on executed transactions and how it is affecting the market price. By analysing this time and sales data, you can perceive the behaviour of the buyers and sellers in the market.

Using this tool you can identify whether there are more aggressive sellers than buyers or vice-versa and also identify the substantial-sized trades that may disclose significant change in the buying or selling pressure in the market. Here you need to scan the data visually and correlate between the shifts in the buy and sell orders at different points of time.

Volume Profile: This is another useful tool providing a detailed view of the volume of trading at different price levels over a specific price. This data is presented through the graphical presentation like a histogram providing useful insights into the volume distribution and trading areas that are highly active in the market.

Also Read: Best Volume Indicators for Day Trading & How to Use for Intraday

To draw this date, you can plot volume against the price levels, and identify the support and resistance levels with area of distribution or accumulation and potential turning points of the market. Overall, it can provide you the useful insights into the relationship between price and volume to determine where substantial buying or selling pressure exists.

Footprint Graphsor Charts: It is a visual representation of traded volume at each price that is shown through graphs or charts. By analysing the patterns you can identify the imbalances that will show you the level of buying and selling pressure at various points of time. Compared to market depth, the footprint chart shows the orders executed in the market.

This will provide you the useful information on buyers and sellers interested in the transactions where the most significant trading activities occur. However, it can be an excellent tool for order flow trading providing the depth of the market directly through price chart.

Level 2 Order Book: Just like the depth of the market, it provides the market data that includes the scope of bid and ask prices for a given security. In level 2, all the information on the depth of the market includes additional information about outstanding limit orders that have been placed above the national best ask and below the national best bid.

You can say that compared to the depth of the market or level 1, level 2 which is also called the depth of the book provides more detailed information like how many buyers or sellers there are in the specific market, the size of the order and what are the bid and ask price of the current market. Finally, it can give you a clearer picture of the participants in the market.

Order Flow Trading Strategy

Along with the above-suggested tools and indicators, you also need the right strategy to make the best use of order flow trading in your strategy. You can choose the footprint chart patterns depth of market and volume profile or level 2 order book to analyse the order flow. However, there are various things you need to consider to make the best use of these tools in your strategy.

Also Read: Top 10 Different Types of Trading Strategies in Stock Market

Analyse the Real-time Data

To use the order flow in your trading strategy, you should have real-time data on the price and volume of trades. The market data must have market depth information like bid and ask orders at various price levels. Using this information, you can evaluate the demand and supply in the market, and based on that you can make the right trade decision.

Keep Watching the Liquidity Imbalances

In order flow trading strategy, keeping an eye on liquidity imbalances can provide you useful insight into the significant gap between the buying and selling pressure at a particular price. And because of these liquidity imbalances, the market can turn around with a breakdown or breakout or there could be trend reversal in the stock price movement can be noticed.

Understanding the Dynamics of Order Book

Apart from the patterns of orders executed in the market, you can also analyse the pending buy and sell orders through the order book. The modification of orders by traders like cancellation of orders, addition of orders or change in the limit price of limit orders etc. are the important dynamics you can comprehend to understand the possible changes in the market.

Identifying the Key Support & Resistance Levels

Using the order flow as a trading strategy, you can spot the key support and resistance levels where a significant amount of buy and sell orders are likely to come together. The concentrations of orders at such key points not only work as support and resistance but could be also a turning point in the market creating a trading opportunity for the traders.

Also Read: Five Best Support and Resistance Indicators in TradingView

Is Order Flow Analysis Good and Profitable for Trading?

For trading and investing technical analysis and fundamental analysis respectively are very important to make the right decision and get the best returns. Just like sentiment analysis and other form analysis, order flow analysis can also be a part of technical analysis. And it helps to closely watch the order flow in the market and how it can affect the market movement.

The order flow analysis can be a good option as it can provide you access the real-time data with certain tools like DOM, time sales data, volume profile and footprint charts to understand the market dynamics that keep changing as per the orders placed in the market.

Traders can utilize the imbalances created through the gap between demand and supply as a trading opportunity while making the right decision in various market conditions. Using this can be a profitable strategy if you effectively analyze the order flow-related market data and execute the same with a well-informed strategy as per your investment goals and trading style.

Conclusion

It basically provides detailed information of buy and sell orders or you can say bids and asks at different price levels with the volume of traders. Using other useful tools you can recognize the gap between buying and selling orders with changes in the market dynamics. This will also help you to trade with right risk management in trading various market segments.

Also Read: How to Manage or Do Risk Management in Options Trading

However, to make the best use of this strategy you should combine the order flow strategy with other indicators and parameters used in fundamental or technical analysis. You can also use the Algo-trading software to analyse such huge data and enjoy the power of high-frequency trading through such automated trading software at low brokerage charges.