The term “Order Flow” throws up mixed expressions when used by different kind of traders. For us at Vtrender and the small community of traders we work with on the Nifty and the BankNifty futures, for every session, OrderFlow trading is a way of life!

For many of us we cannot think about placing a trade today without looking at what the Order Flow information is telling us.

For today I want to take a step back and delve into what we look at when we are wanting to see these Order Flow charts. But for that, we need to have a realistic look at the marketplace of today and by that, I mean the shortest time frame used by derivatives traders like me every day. If you are into derivatives trading, you may like to read on. For the investors working only on the concept of “time will make everything right” and the oft-repeated ” mutual fund sahi hai” this is not for you.

The derivative world of the kind I knew, changed forever in 2007 when the word “HFT” or high-frequency trading became common lingo. The media got into it with that “all I know is that I know everything’ kind of attitude and HFT was equated with speed and proximity and “risk-free” trading etc. etc. It hardly is and they make as many losses as us, though some are engineered for a “getting to know you” or a future strategy. The media went on to say that HFT’s won all the time ignoring the few dozen (maybe more) firms which went belly up every time the market moved away from the normal. Even today anytime any instrument does a 2 sigma move, I scan the papers to see if any HFT went under!

Back in 2008 a lot of us were told that with the advent of HFT most of retail would be out!! Such statements made even today show that people have a very little understanding on how the markets run or work. Markets have always been about an auction process between a Buyer and a Seller and an aggressive player/players drive the market up or down in their pursuit of value. This value is a perception, a landscape and a clean understanding of this principle fuels a price move. If there is a landscape (read markets) and players in the landscape with differing views the markets will function depending on who has the bigger edge in understanding the changing landscape in every time frame. This has been true, whether you traded the markets in the past decade the past 20 years or the last 50. And it’s also the reason that retail who can see or have a bigger edge can easily beat sophisticated programs who often come to the market with an established bias.

In the Trading word of today a distinction need to be made between algorithmic trading and HFT and the newest kid on the block AI (Artificial intelligence) which is poised to make quite a few HFT techniques redundant.

Algorithmic trading is machine generated orders without human intervention

HFT would be the same on a bigger scale. There is an important difference between the 2 and all algorithmic trading is not HFT.

Artificial Intelligence or AI is the newest kid on the block and would one day take down HFT

So, what are the kind of strategies these machine executed orders look at? to secure an edge however small that may be

Index Arbitrage – This is by far the most common algorithmic execution method used and it may not be all HFT. It involves selling the index futures and buying the underlying cash stocks. When done with big quantities it can generate lots of returns. It is very popular for an instrument such as the BankNifty which starts a series with a premium of 150- 180 points and closes at zero. Terms associated with it are “basket buying” as also “program trading”. The term program trading is generally also used for buying a basket of stocks maybe more that 15 or 20 at a time with an execution focus on time rather than price.

Latency Arbitrage – Latency arbitrage is all about speed differentials and involves having a different view of the orderbook at the same period. This is used by proprietary firms who have broken the 1 second barrier and gone to micro seconds to have a view of what the order book is. The predator in this case mostly a proprietary trading firm uses processes to scan the order book looking for big institutions and funds who are about to enter a big order in the market. Data about price changes must literally travel the distance between participants, and that trip can be faster or slower depending on the technology a firm is using and how far a participant is from the source of the data. Speed is the key here and put to max use by a proprietary firm who can single out an ETF or a fund still dependent on a legacy execution method due to regulatory obligations etc. These prop firms base their trades on what price will do next sensing the big orders coming in the next few micro seconds and are almost instantly profitable

Market Making – Buying the bids and selling the offers 1 or 2 mini steps at a time. This is extremely small sized trading not more than 10 lots at a time and designed to keep the liquidity of the market unaltered. Works extremely well in low volatility environments where price movement is not much. HFT’s use the almost stationary prices to make fractions based on a probability law. Not all trades are profitable, and some are also scratched at cost. But it improves the liquidity of the market immensely. Focus is kept only on the top of the orderbook and is extremely rewarding for all liquid stocks and indices. Won’t work as well with illiquid instruments

Sentiment/ news based HFT – These are different and often contradictory HFT’s competing often in times of news flow or a sudden aggressive change in the market sentiment. This is seen around news events such as the RBI meet or the FM Live during market hours or some other CMD of a company appearing on Live TV in market hours. Algorithms are tied to keywords in the information newly flowing in and can tell the prop firm in milli seconds whether the information is positive or negative and positions are built accordingly. This works extremely quickly, and the move is often over before someone at a retail desk can hear it, let alone process it. Often the biggest explanation for why price moves quickly as a certain news break. The predatory HFT can move an instrument like the BankNifty up or down 200 points in microseconds even as something like an RBI news is just breaking

Spoofing/ layering – Almost extinct today and declared illegal in the US. This involves placing limit orders in the order book for executing at a higher or lower price than the LTP but removing them before they are executed. The spoofer hopes to see the actual demand and supply in the market by such an activity. Layering involves placing the same kind of orders evenly across different prices. The most famous case of spoofing was that of Navinder Singh Sarao who was held responsible for the flash crash back in 2010

Exploratory Trading – This involves an HFT creating orders and executing them to test demand or supply beyond a known level of reference and booking out when the momentum is establishing. This strategy is also popular as a momentum ignition strategy. The HFT instigates other traders to take positions by building smaller orders and causing other market participants to trade aggressively creating a price move. He then trades out. The HFT uses this strategy to identify the zone for a future order and is gauging the liquidity and the demand-supply at that place. The HFT generally loses on the first few trades whilst assessing the demand/supply but covers up once the momentum ignition has happened. Also, information flowing in the form of the actual demand or supply at that point is marked for later

Artificial Intelligence – This is the big Daddy of them all and would eventually replace the HFT which has dominated the landscape this decade. The difference between an HFT and deep learning strategies if that they do not approach the market or the trade with a pre-conceived bias but examine the data for any useful information it might contain. Deep learning does this by using layers to summarize the content of previous layers and the deeper it goes the more intelligent it gets. These are immensely complex relational strategies and engineered by the smartest brains on the planet today. Constant tweaking and redevelopment as also substantial investments is required to get to the final objective but the absence of a bias to begin the process, marks AI as the one to watch for the future

So, to sum up, this is the complex world we are trading with as derivative traders now especially those of us who are in the shortest time frame.

This is how our competition today has evolved and to match it we have to begin with a knowledge of what it is.

At Vtrender we make efforts to undertand the who, what, where, why and how, first before forming our own strategies and tweaking it to ensure that we stay with an edge This is the situation today and it may be different tomorrow. Infact there never has been a time in history when the markets haven’t changed. We are the market- you and me.

For that, I must know my “me” – and that is my strategy well

And I must also know the “you” – the people and the institutions who are trading on my side or the other side.

OrderFlow can show me who is on my side or the other.

Thankfully I have invested in the knowledge of OrderFlow to know this. Have you?

To read more about how an OrderFlow chart will benefit you go here – https://vtrender.com/why-i-trust-an-orderflow-chart/

To know more about how to implement best practices in OrderFlow reading visit the Vtrender Trading Room at – https://vtrender.com/trading-room/