Traded Volumes in Order Flow - A New Perspective
In the complex world of derivative trading, one cannot underestimate the role of traded volumes in predicting future market moves. Even seasoned traders occasionally find themselves “upside down,” a situation where their trading positions are at odds with the prevailing market direction. This article delves deep into how traded volumes, particularly in scenarios where traders are caught on the wrong foot, act as precursors to significant market movements.
Understanding "Upside Down" in Trading
At its core, being “upside down” means having a trading position that is counter to the market’s direction. For instance, if a trader goes short, predicting a price drop, but the market rises, they find themselves in an “upside down” situation. This can also happen to those going long, where they anticipate a rise, but the market drops.
Two essential reactions occur when traders find themselves “upside down”:
Short Covering: This happens when traders who’ve gone short start to buy back their positions to mitigate losses when prices go against them. Essentially, they’re covering their short positions, hence the term. It often leads to rapid price ascension as multiple short sellers rush to cover.
Long Liquidation: This is the opposite of short covering. In this case, traders who’ve taken long positions begin to sell off as the market starts dropping. As multiple traders do this, it can lead to a sharp price decline.
The Big Tell in Traded Volumes: A Look at Buy-Sided Trades vs. Sell-Sided Trades
In the intricate world of Order Flow, traded volumes act as an illuminating beacon, revealing a comprehensive picture of the market’s psyche. The sheer beauty of Order Flow is its ability to split trades driven by buyers from those propelled by sellers. When such trades are sequentially plotted, they foster imbalances that hint at the subsequent market movement. This distinct advantage of differentiating buy-side from sell-side is pivotal for traders to ascertain the market’s next step.
How Buy Side Volumes and Sell side Volumes Inform Strategy
The chart above is a classic Orderflow chart with buyers or greens on the right side of the bar and sellers or reds to the left of the bar.
Thus demand is on the bright side and they try to push price up and supply on the left tries to push price down.
The Orderflow adds information to the chart, allowing us to see real time what is happening between the highs and the lows of the bar and the opens and the closes of the same bar.
The wisdom in analyzing traded volumes this way lies in its potential to capture the true market sentiment. With Order Flow, one can dissect the layers of market dynamics, from the simplest buy-sell interactions. Thus a stack of reds at the top of the bar is a signal that sellers have created an “imbalance” and price can now move lower. Similarly a stack of greens anywhere on the bar indicates a potential to move up. This works anyday better than making educated guesses on what price can do next. Simply put, you now have a clean decisive way of knowing what price can do next!
The Behavior Dichotomy: Positioned vs. Ready-to-Enter Traders
It’s essential to differentiate between traders who have active positions in the market and those yet to build or enter a position. The behavior and strategies employed by these two categories of traders can vary drastically:
Positioned Traders: Once a trader has volume in a trade, their behavior is largely governed by protecting their position, managing risk, and mitigating potential losses. They might sometimes deviate from their initial strategy or plans, especially when the market moves against them. Their reactions to market changes are often immediate and can be emotional, leading to rapid market moves.
Ready-to-Enter Traders: These traders, with orders lined up in the order book but not yet triggered, have the luxury of patience. They can wait for the right conditions, adjust their strategies in real-time, and are less emotionally tied to the market’s immediate moves. Their decisions are often more calculated and less reactionary compared to positioned traders.
Hence tracking the behaviour of traders with established positions in the markets makes more sense than checking the Orderbook where there is no guarantee that the waiting traders may actually push the trade.
The Domino Effect of Big Traders' Miscalculations
Even the big sharks in trading waters aren’t immune to misjudgments. When they find themselves “upside down,” the sheer size of their trades means their reactions can send massive ripples across the market. If they’ve placed sizeable short positions and the market starts rallying, their scramble to cover those positions can lead to exponential price jumps. On the other hand, if they’re predominantly long and the market plummets, their rush to sell can exacerbate the price drop.
It’s a game of dominoes. When one big trader moves, others often follow suit, amplifying the effect.
The Power of Order Flow in Deciphering the Game
Order flow isn’t just about monitoring the numbers in trades; it’s about understanding the story behind those numbers. It provides insights into:
Who’s Driving the Bus: By analyzing traded volumes, one can gauge whether small retail traders or big institutional traders are dominant at any given time.
Positional Play: Through order flow, one can spot the traders who are “upside down” and those who’ve got it right. This understanding offers predictive power for potential price moves.
Market Waves: As big traders react to market moves, either by short covering or long liquidation, they create waves. Identifying these waves early on can lead to profitable trading strategies.
To close
In trading, understanding the narrative is as crucial as crunching the numbers. Traded volumes, when studied in the context of order flow, offer invaluable insights into market dynamics, especially when traders find themselves “upside down”.
Recognizing the differences in behavior between positioned and ready-to-enter traders further adds nuance to our understanding.
Remember, no trader, no matter how experienced or influential, is immune to misjudgments.
But with tools like order flow at one’s disposal, one can not only understand these miscalculations but also potentially profit from them.