In comparison to other trading disciplines, order flow trading does not contain that many trading strategies you can use, at least not in the forex market. The reason why, is because there is no proper order book available which you can use to see when buy and sell orders are entering the market in real time. We have Oanda’s order book, but that has big limitations and does not substitute for a real order book we’d be able to use if we were trading futures or stocks.
Despite the fact there is no real order book, there are still some order flow trading strategies we can use in our trading, two of which I’m going to show you in today’s article. The two strategies I’ve picked for this article aren’t full order flow trading systems, so you don’t have to worry about changing your current trading strategy in order to trade them, you can just use them as additional setups to watch out for when your trading the market.
Order Flow Strategy #1 Using Oanda’s Order Book To Trade Stop Hunts
Oanda’s Order Book is one of the few order flow indicators out there which offers its users an inside look at where forex traders have got their buy and sell orders placed. The fact that it lets you see where the orders have been placed, means you can use it to trade one of the oldest order flow trading strategies out there, ‘the stop hunt’.
The stop hunt, (or stop run as people often call it), is what happens when the market spikes through a point where a large number of retail traders have got their stop losses placed. The reason it occurs, is because the bank traders know that by causing the market to hit a bunch of stops, they’ll have the opportunity to get a large number of their own trades placed at a favorable price, or will be able to take a big chunk of profits off trades they’ve already got open.
Finding out where stop hunts were likely going to take place used to be based on an understanding of order flow and how traders think and make decisions. This method of trading stops hunts had varying degrees of accuracy, because you were essentially guessing where traders had got their stop losses placed in the market, instead of knowing for sure where they were located. The discovery of Oanda’s Order Book changed all this, because it let you see the exact prices at which traders had got their stops placed, allowing you to see the points where stop hunts had the potential to occur into the market.
I’m not going to detail the exact method of trading stop hunts in this article, because I’ve already written a lengthy post on it which you can find here, but I am going to run through a quick example of a stop run which took place on EUR/USD, just so you can see they occur in the market.
If you look at the open orders graph to the left of the image, you can see there was a large build of sell stop orders around the 119.500 level on USD/JPY.
The fact that so many stop orders have accumulated at this level means it’s likely the bank traders are going to make the market run into the stops, to either get lots of buy trades placed at a decent price, or to take some profits off sell trades they’ve already got open.
You can see that once the market hit the sell stops the price moved higher, and by the end of the hour had caused a bullish pin bar to form. If you were trading this stop run the bullish pin bar would be the signal you use to enter your buy trade and trade the reversal. It’s formation is a sign the bank traders have indeed caused the market to move into the buy stops to get buy trades placed, or to take profits off sell trades. In this instance the banks decided to use the sell stops to take some profits off the sell trades they’d got placed at the swing highs created on the 5th October. We know this to be true because of the 150 pip drop which took place once the market broke through the swing low created by the stop run.
What makes trading stop runs using Oanda’s Order Book such a great order flow strategy, is that the setups it provides you with have a high probability of working out successfully, and will often get you into trades at the same time as when the bank traders are getting their own trades placed. Even when you end up trading a stop run caused by profit taking, the resulting reversal is usually large enough for you to make some decent profits, or at the very least allow you to exit the trade without losing any money.
Order Flow Strategy #2 Watching For Breakouts To Occur From Small Range Consolidations
Watching for breakouts to occur from small range consolidations is another order flow trading strategy you might want to consider adding to your current method. It’s similar to trading stop hunts, in that it’s a setup which doesn’t occur very often, but when it does will usually provide you with a good trade that has a high probability of working out successfully.
The main idea behind the method is to get into a trading position when a large number of other traders are in the process of liquidating losing trades. Closing a losing trade means doing the opposite to what you did to get the trade placed initially. For example, if you placed a buy trade the only way you can close that trade is by using a sell order, which means when you close the trade no matter whether it’s at a profit or a loss, a sell order will be executed into the market. Now if a large number of traders are all closing their losing trades at a similar time to one another, a lot of orders are going to be entering the market and causing the price to move.
If you can get a trade placed right before these traders are going to close their trades, you can profit from the movement their liquidation is going to create.
A small range consolidation is basically a consolidation which has similar sized swings, and has it’s highs and lows form at similar prices to one another. The two consolidations you can see in the image above both contain all of these elements. The swings which make up their construction are relatively equal, and most of the highs and lows have formed at similar prices, as evidenced by the fact that it’s possible to draw a straight line through the highs and lows and not have any stick out by a large distance.
Now the down-swings which you can see take place after each consolidation has formed, occur primarily as a result of the traders who went long inside the consolidations closing their buy trades at a loss. These traders would have got their buy trades placed somewhere close to where the highs of the consolidation formed, so when the market starts the drop out of the consolidation, the size of the loss on their trades increases to the point where they can no longer handle holding their trade open, and decide to close them out of fear of potentially losing any more money.
This occurs at roughly the same time, because the traders have all got their long trades placed at similar points to one another (i.e the highs of the consolidation), so when they close their trades a huge number of sell orders enter the market and cause the price to drop. The important thing you need to understand, is that they only close their trades when faced with a loss much bigger than what they were at previously. If their loss only increases by a small amount, they won’t feel compelled to close the trade and no big down movement will take place.
So the key to trading the small range consolidation breakout, is to get a trade placed on the candlestick which causes the loss on the losing traders trades to become much bigger than what they were before.
This candlestick was the one which caused the traders who went long inside the consolidation to start closing their trades at a loss. The reason why was because it caused the loss on the traders trades to become much bigger than what they were before. If you look at the three bearish candles which formed before, you can see they are all tiny and did not cause the market to fall a large distance. The fact they didn’t cause a large drop to take place, means the majority of the traders who were long didn’t bother closing their losing trades, because their loss didn’t become big enough for them to get scared of losing a large amount of money.
This all changes when the big bearish candlestick forms, because that creates a much bigger drop and causes the traders trades to go into a loss much larger than the one they were in when the smaller bearish candlesticks formed. Their loss becoming much bigger is what causes them to close their losing trades and create the move down we see after the big bearish candle has formed.
The big bearish candlestick you can see in this setup is the signal you would use to enter a small range consolidation trade. When you trade this setup yourself, you need to look for the candle which causes the loss on the traders trades to increase dramatically. These candles are usually very big when compared to the previous candles which have formed before it, and will push the market either down to the lows or up to the highs of the consolidation itself. Your entry into the trade would be right after the candle has closed, and your stop loss would be placed above the high of the candle, if it was a bearish setup like the one in the image, or below the low of the candle if it was a bullish setup.
Although trading breakouts from small range consolidations is a little bit more difficult than trading stop runs, it’s an order flow strategy which can yield great results when learnt how to trade properly. Figuring out which candle causes the traders to close their losing trade is usually the hard part, but after going back and seeing some examples of breakouts from small range consolidations taking place, you should get a pretty good grasp on kind of candlestick you want to see in order to enter a trade.
Hopefully the two order flow strategies in this article will give you with some successful trades and help you increase your profits from the market. They may not be the easiest of trading strategies to actually learn and trade, but the payoff you’ll receive for mastering them will more than make up for the time you had to spend learning how to use them.
Thanks for reading, please leave any questions in the comment section below