This setup we took in our Trading Room shies away from our conventional supply/demand and harmonic pattern analysis. This will be the first of many trades that we will take using order flow analysis.
Looking at the chart above, we identified that price was in an uptrend, but there was downside potential as there was a dynamic support in the form of a trendline. Therefore, our bias was to short the pair. I’m not going to go into full detail what order flow is, perhaps in another article. However, if it’s one thing I want you to take away from this article about order flow analysis, it’s that our goal is not to look at the candlesticks on a chart, but rather the empty spaces, because we want to try and identify where retail traders place their stop losses.
With that in mind, let’s take a closer look at the chart. You can clearly see the uptrend as price moved from the lower left to upper right side of the chart. That’s when the market found sellers at resistance and price began to drop. It was this drop in price that had caught my attention.
Notice how price had dropped quite quickly before slowing down. This meant either two things. Initial sellers had exited their positions in profit with a buy limit, or new participants entered with buys. It is important to understand the different types of orders in a market. When you have a sell position, to close your order, you will need to buy it back. So your stop loss and take profit levels are both buys when you sell an asset.
I was thinking to myself, sellers who caught the initial move downwards did two things; moved their stop losses lower to protect their profits and closed their sell position with a buy. This meant that if my theory was true, price would breakout of the trendline before falling again.
This cluster of stop losses gives liquidity to the market, and gives institutions the opportunity to match their sell orders with the buy stops, which are stop losses.
As you can see from the chart above, price did exactly as I had analysed. Price broke out strongly from the trendline before running into a cluster of stop losses, which is exactly what the institutions wanted. They want this because liquidity to them is an issue. Unlike retail traders like us, they have difficulty filling their orders due to its sheer size. Therefore, stop losses of sells are buy limits, and by limits provide liquidity to the market.
This was more or less a straightforward setup, with price hitting my target, although there was a spike up back towards my entry. This can be explained using order flow, but I’ll save that for another article.
See you on Monday for our webinar!
Psst…we’ll even throw in a discount to get you started!