TradingTheTape was founded in 2006 to study how volume affects price action and market momentum. This led to automated trading strategies that placed and managed trades based on criteria pre-determined by the user and without any further input from the user. Today these program trading strategies run on Chicago-based dedicated servers that can be controlled by a smart phone. Current software development is focused exclusively on automated order flow analysis for both scalping and trend trading, both discretionary and fully automated program trading, for both thick and thin markets.
“Order Flow Determines Price Action ~ To See The Future, Watch The Order Flow”
How to trade using Order Flow Analysis (Tape Reading)
What is ‘the tape’? Think of a trader in the 1930′s jumping out of a 40 story window trailing a long paper tape behind him and you get the idea. He just read the tape and all his holdings are plummeting on heavy volume…i.e. the market momentum is screaming down, it is not coming back and he is wiped out. The tape back then literally referred to a ribbon of tape spewing out of a glass-domed ticker machine (hence the term ‘ticker tape’) with a live market data feed with prints on the tape of the last price and volume of various stocks. In good times there would be ticker tape parades. In bad times there would be ‘jumpers’. The ‘tape’ therefore refers to order flow, which is volume at price, i.e. what size traded at what price.
Today the tape figuratively refers to the typical Time and Sales window shown below. Same concept of volume at price and colored as to whether the last trade was at the Bid or at the Ask. The problem with the Time and Sales window today is that, even if you could read it, it can and does give misleading information relative to forecasting price action. For example, a rapid series of green prints does not necessarily mean the market is going up and one should buy. Instead the prints could all be at the same price and the ‘big money’ is absorbing all the hits on the Ask until the market is forced down. In this case all those green prints mean sell.
In conjunction with the T&S window today’s traders typically look at a Depth Of Market (DOM) window which shows the Inside Bid and Ask plus 5 to 10 levels of orders below the Inside Bid and above the Inside Ask. The DOM can be beneficial to the experienced trader who realizes roughly 80% of the Bid and Ask offers are fake or spoofing. To a novice trader the DOM can be very misleading.
Why are the T&S and DOM unreliable for trade entry?
(Hidden Orders and Spoofing)
Ok. So what are traders trying to discern from the T&S and DOM anyway? Essentially they are trying to forecast future price action. Where will the market go? Not, where has it been. A common theme is “Where is the big money? Are they buying or selling?” Can future market moves be predicted by watching the ‘big money’? Yes.
‘Big’ is a relative term and ‘Big Money’ is relative to the market being traded. For example Big Money in a thick market, such as the 10 Year U.S. Treasury Note Future (“ZN”) market, refers to a trader or group of traders that trade thousands of lots. A 50 or 100 lot trader in such a market is insignificant. However, Big Money in a thin market, such as Light Sweet Crude Oil Future (“CL”) market, might refer to your 20 or 50 lot trader.
Essentially Big Money is trading size that can ‘carry’, stop and/or reverse a market. Due to their relative size, their position and actions are easily recognized and tracked with a little practice and the right tools. Big Money is like a bus in the middle of a parking lot full of cars. The bus stands out, it can crash through the cars with only minor resistance and it will keep moving until it hits another bus or decides to stop or turn around.
Big Money in a thick market includes: banks, merchant banks, hedge funds, market makers, large proprietary firms and traders, and anyone else with an account balance in the millions of dollars. Big Money decides where and when the market is going next and when it will stop and/or reverse.
If you have any doubts about big money players controlling the market, read the following excerpts from the Upstairs vs Downstairs Debate.
Logically Big Money players set trading levels when they enter and exit the market due to the sheer size they are trading. These levels show up on charts as high volume nodes or points of control. The high volume nodes are interspersed between relatively low volume price levels. Why? This is because large players need to trade with other large players to get in and out of the market. For example, if the market is going up on medium to low volume and a big player decides the price of 100 is high enough and they “sit on the Ask” or start absorbing all the buying at 100, then a high volume node begins to form at 100. At this point who is going to keep buying? So the market drops back until it hits supporting volume. Assuming the big player is looking for 5 ticks of profit he sits on the Bid and absorbs all the selling at 95. Another high volume node forms at 95. Now there is high volume at 100 and at 95 and relatively low volume in between. In this example note that the resisting volume and supporting volume are the same big player(s). They made that move happen. Hence Big Money has a huge advantage as they can see the short term future since they are the short term future…i.e they know they are going to sell up to 10,000 lots into the market to force it down and then buy it back for a profit. But isn’t that market manipulation? Yes of course it is…but they are making a market and providing liquidity, right?
So volume goes to volume? Yes it does. If in the example the big player started covering his short at 99 he would drive the market back up to his 100 entry price price and ruin ‘his’ market. The result would be a 1 tick battle between the big players…a scenario that we want to watch for and avoid. If the big players are able to more the market 5 ticks, take profit without adversely affecting the market and then move it another 5 ticks, we want to increase our size and trade with them since our risk is very low (1-2 ticks)
Then how does the big player trade size without ruining the market? Hidden/Refreshing/Iceberg orders. In the example, the big player does not offer 10,000 lots at the Inside Ask at 100. Instead he offers 800 when size at the Inside Bid at 99 is 3200. On the DOM the market looks strong right? i.e. four times as much buying pressure as selling pressure right? Wrong. The small 800 offer is intentional. Hidden behind the 800 is another 9,200 he intends to sell if he can find buyers for it. Hence all the green prints showing hits on the Ask at 100 on the traditional T&S mean nothing. Green in this case means sell.
What else does the big player do to trade size? In the example he is probably most of the 32oo volume at the Inside Bid at 99. He is inducing buying into his hidden order. Then when he has all he thinks he can get he will pull his Bid and let the market drop. He was just kidding or ‘spoofing’. Hence the DOM 800 Ask size was fake and most of the 3200 Bid size was fake and reading the traditional DOM to a novice trader can be very misleading and costly.
So if we can see and understand what the market movers are doing we have a higher probability of where the market is going next and we can trade increased size with reduced risk.
Why are you risking 10 ticks when the Big Money is risking 1 tick?
1 lot x 10 ticks @ $10.00/tick = $100 Trade Entry Risk
10 lots x 1 tick @ $10.00/tick = $100 Trade Entry Risk
Trade What, When and How the Big Money Trades
A Chicago-based server is highly recommended to take full advantage of the Risk Algorithm
What can a 1-lot novice trader do? Quit or persevere? Well, trading for a living is very difficult with an expensive learning curve so quitting would be the cheaper and less stressful option. Before giving up you might consider if you are trading the best instruments for success or just the most popular instruments everyone else trades, i.e. boring thick markets or wildly exciting thin markets. Then you could try so survive while you become an expert at finding and following Big Money action using the T&S and DOM. Or you could try to get an edge using some alternative tools that reveal more about the market and big players than the standard tools.
Alternative Tools for Trading Based On Order Flow/Tape Reading (©TTT_Auto_OF)
The only relevant information required from reading the Time & Sales and Order Book/DOM is the current pressure and market reaction to that pressure. ©TTT_Auto_OF automatically analyzes order flow and integrates this information on the chart for discretionary trading and automated risk management and, with discretion, for automated trade entry. This information is used to automatically exit trades based on order flow thereby reducing stop loss tolerance to as low as 1 tick in thick markets such as the ZN 10 Year U.S. Treasury Notes Futures. Although not required, a Chicago-based server is highly recommended to take full advantage of the Risk Algorithm and automated entry/exit features.
©TTT_Auto_OF is a tool similar to other volume-based indicators with the addition of automated risk management and order entry, all based on order flow pressure. The order flow analysis is automated, not your trading discretion. The key concept here is if you know within 1 or 2 ticks that you should exit a trade, then why wait for a 4, 6 or 8 tick stop to get hit. Similarly, if you know within a tick where the market is most likely to move next, then that is a good place to risk 1 tick on entry and you should take the trade. Further, once a trade gets to break even and your market read based the order flow confirms continuation you should add to your position, again while only risking 1 tick. At all times you have the discretion to take trades manually or using automation. You also have the discretion to exit the trade manually or with automation. Your discretion is enhanced by the information plotted on the chart by the tool. Extensive training on when and how to use the tool and even when to trade/not trade is included with the tool.
Introduction To Automated Order Flow Analysis
Advanced Automated Trading – Order Flow + Price Action
More important than how to read the order flow is ‘which’ order flow to read…i.e. which instrument to trade. Trading a thin market using order flow and trading a thick market using order flow are significantly different. All markets move based on order flow – the thin markets just move further and faster on relatively very low volume/order flow.
Because Thin Markets move on low volume they are easily influenced/manipulated. The big moves in a thin market come from the fact that there is very little volume to resist the move. The volatility in a thin market comes from the move-initiating-players taking profit i.e. there is no volume to resist the market going back to where they started the mvoe. Due to the volatility thin markets require larger stops than thick markets. A big problem with thin markets then is how to increase size to make a serious amount of money without also incurring unacceptable risk. The ES is arguably the most popular and widely traded future contract and allows larger size yet it also trades like a thin requiring perhaps 4 to 8 ticks of risk per trade. Trading 10 lots with 4 to 8 ticks of risk at $12.50 per tick equates to $500 to $1,000 risk per trade and, due to relatively high volatility, the winning percentage will be lower than for a thick market.
Thick Markets move based on very high volume and as such are more predictable/less volatile. The ZN 10 Year US Treasury Note future contract for instance typically holds key support/resistance levels with 10-20,000 lots and requires 2-3,000 lots of order flow pressure just to move 1 tick. This means a smaller number of very large/Big Money players are controlling/influencing the ZN market and trading ‘with’ them has far less relative risk than trading a thin market. It is entirely feasible to trade 10 lots with 1 tick risk at $15.625 per tick or $156.25 risk per trade and with a much more favorable winning percentage. The 1 tick risk per trade is possible due the predictability that comes from the size being traded. For example if you are long during a session and the volume profile nodes are averaging approximately 10,000 lots 4 to 5 ticks apart and 20,000 lots print above your position, why would you stay long and suffer 4 to 8 ticks of pullback? You know the Big Money is causing the pullback by taking profit and that the Big Money players holding 1,000′s of lots each are not going to take more than a tick of pullback so why should you? Per the Tom Baldwin quotes they will take the market as far as they can and then reverse and take the market as far as they can. So if they can not hold and advance the market, why are you staying in the trade? Similarly on entry, either the Big Money is supporting the move or not. If you go long and their support/pressure does not continue, do you need more than 1 or 2 ticks proof that the move is not working? If the market movers can not move the market more than 1 or 2 ticks without being forced to exit, why are you sitting in the trade with a 4 to 8 tick stop ‘hoping’ for 5 or 10 ticks profit?
Key to trading any market is the size of the pullback on profit-taking. If a market is moving up and only pulls back 2 ticks on low volume before proceeding up then it is very strong, very predictable and can traded with increased size and low risk. If the same market pulls back 3+ ticks on higher volume then the market is not strong enough on profit-taking to maintain the move and you should exit also. Thicker markets make those decisions easier.
Having said all that, thin market also have order flow and can be traded on the relative size of that order flow using automation…
Automated Order Flow Trading For Thin Markets (6E)
©TTT_Auto_OF automated order flow analysis strategy enables trading based on order flow analysis (tape reading) and based on price action. Global Risk Management parameters (user defined) include Risk_Per_Session, Max_Drawdown_Session and Profit_Target_Session. Trade management features include order flow exits, profit trapping, automated stop placement and management, market bias, auto reverse, auto break-even and instant exit. All trade management is based on analysis of the order flow allowing entry risk control as low as 1 tick. Users can increase this tolerance for thinner markets. All key features are user-interfaced directly on the chart allowing real-time one-click changes for quick response to changing market conditions.