In your recent blog you said something that hit home….the fact that order flow/info. flow analysis can get you in EARLIER and at better prices than most other traditional signals like price action setups….I’m assuming this means, as an example, getting in ON the pin bar, rather than further way after the pin bar has been shown on the charts….something like that? In other words, not having to “wait for confirmation”.
Also, how order flow and info. flow analysis can give you more (or less) conviction on a trade to bet more or less.
Also, another revelation…..when you say sentiment….or sentiment analysis…this is really risk-on or risk-off….risk appetite or risk aversion……correct?…The way I see it is there are individual currency trades, betting on the interest rate direction on a certain country versus the direction of another country….like, for example, going long USD/JPY based on betting on a Fed taper and BOJ doing more QE. But another important way of setting up trades is betting on risk aversion/appetite….
So in other words, 2 basic ways of structuring trades…1) individual country versus another individual country, strong versus weak……..or, 2) overall sentiment/ risk sentiment/market conditions – the big picture.
So in other words, we do the daily habits to follow the individual countries…strong versus weak……..and the overall market (stocks, bonds, crude, gold) for a feel/sense of risk sentiment (risk appetite/aversion), the big picture. And then it is the combining of these two is what leads us to structure trades.
Any thoughts on this?
It is my belief that when a trader breaks free from the constraints of tech indic/chart and price patterns, embraces some form of order flow, information flow, scenario analysis, news/sent/fund/macro, then a whole new world opens up to them. It happened to me, although some of the macro stuff came gradually. I was kind of shocked as to some the things I discovered and the philosophy and principles I was able to develop and explain in the Mastery Course.
The reason is because the techn indic/chart/price patterns all have self imposed limitations. All systems have limitations and some rules and guidelines. But when you have a trading system that isn’t exactly based on market truth like a moving average crossover, or Fibonacci, etc, then the limitations of the system kill off a lot of trading potential and creative market thinking.
As a simple example, lets say USD/JPY is in a downtrend, but it is trying to consolidate. The moving average crossover trader is going to wait first until the market rises a few hundred pips or 1,000 pips, before their moving average signals to buy USD/JPY, depending on what moving average crossover settings they have, etc. So there is a lag, a pretty big lag. Why should you have to wait for the market to move 400 pips or 1,000 pip first before you get in? It doesn’t mean you should or should not wait. I am just saying why force yourself into a trading system that always lags so much? By the time the market moves 1,000 pips, who knows, the macro scenario could be played out (macro exhaustion concept) and you may be getting in late and there is no more volatility in your favor.
Then the next step up is the charts/price pattern trader. They realize that tech indicators may lag too much, and they try to find some chart patterns or price patterns to get them in earlier to the move. Maybe the trader sees USD/JPY trying to consolidate and forms a box and tries to buy it after it breaks out higher. Perhaps they can get in earlier than a moving average trader because the chart pattern trader may place a buy stop above resistance or something. The price pattern trader may want to wait for a bullish engulfing pattern or Pinocchio bar or inside bar breakout higher, etc.
These are all limiting concepts due to numerous reasons, but one key principle stands out: The big money that will move the market (the news/sent/fund/macro players) don’t care much about moving average crossovers, or chart patterns, or Pinocchio bars, or any of that stuff. I think there is a small amount of value in certain key moving averages, such as the 50, 100 or 200 MA on perhaps the daily or weekly chart, but when I say a small amount of value, perhaps it is 1-5% or something. And there is some value in some basic chart congestion patterns and high/lows to find the stops. Beyond that, the 70-95% of the market movements, will depend on what the news/sent/fund/macro players are doing.
Since the tech indic/chart/price pattern traders are not trading systems and do not have a philosophy that is based on what really moves the market, they are limiting themselves in a very big way.
I always wanted to know why the market was moving. If I could figure out why the market is moving, then I can figure out what can make it move faster, slower, cause it to reverse, consolidate. If I can figure out why something works, there is a much better chance I can figure out why it would stop working, etc.
When you enter the world of order flow, liquidity, information flow, scenarios, etc, then you are not limited by any tech indic, chart or price patterns. By definition the tech indic/chart/price patterns wait for confirmation from the patterns that they are supposed to see on their charts. The moving average trader waits for confirmation from the moving averages crossing over. The chart pattern waits for a chart pattern to form and for the entry criteria to be met. The price pattern trader waits for a price pattern to form, then they buy on a bar close or a breakout of the bar, etc.
That doesn’t mean order flow trading doesn’t have limitations or guidelines or rules. It does have those things. But since they are based far more on the market truth and what really drives the market, you have a far more robust and flexible strategy and philosophy.
Now when an order flow and global macro trader sees the same USD/JPY situation above, he doesn’t really care about what the chart is saying. He is interpreting the information flow, scenarios, trying to figure out when the news/sent/fund/macro players are going to come in to cause volatility and reprice the market for a different scenario and change in expectations.
Whether or not an order flow or global macro trader “lags” is all dependent on their interpretation of the information flow.
As Bill Lipschutz said:
Not everyone is going to interpret things in the same way, at the same time, as you do, and it’s important that you understand that.
The global macro trader can place a trade trying to catch a falling knife. They can try to fade the downside stops and barriers to get in. They can try to buy in the middle of a consolidation. They can buy after the market breaks out above the key highs. They can buy after the market has already run up a few hundred pips. They are not limited by the chart. They are only limited by their perception of the information flow and scenarios and reward to risk at that moment in time. The macro trader realizes that the financial instrument they are looking at can react differently depending on the macro environment and the information flow and scenarios that are in play. They realize that sometimes it can be absolutely fine to try to buy the market when it is falling hard, sometimes it is fine to buy the market after it trips downside stops, other times it is fine to buy the market after it breaks above a recent highs, other times it is fine to buy the market after it has run up a lot. They recognize that it all depends on the financial instrument at the specific moment in time, and whether there exists news/sent/fund/macro traders to push the market in their favor.
For example, when Soros shorted USD/JPY in 1985, he first shorted it at the lows of the move, then it retraced higher by a few hundred pips and he was in drawdown. Then after the Plaza Accord, USD/JPY gapped lower by 500-1000 pips and made fresh lows. Soros still shorted the hell out of it with a few hundred million more, even though the market was on fresh lows and the market already gapped down 500-1,000 pips. Because he knew it wasn’t about what the chart said or any of that. It was about what the information flow and macro pressures in the market at that moment in time. If the news/sent/fund/macro is still going to hammer a market lower because they perceive a fresh information flow or macro scenario, then the market is going to keep going down.
I try to explain these concepts in principles when I talk about the “macro model” and in the Order Flow Liquidity Model: http://orderflowforex.com/order-flow-liquidity-model-revised/
A small portion copied from the Liquidity Model lesson:
Some of the most critical order flow and liquidity components include:
1. News/sentiment/fundamental/macro participants which are sitting on the sidelines with their powder dry waiting to commit to a certain scenario.
2. How much size and market players have already established positions, and betting on a certain scenario, and what scenario/trigger/catalyst will cause them to unwind their positions. Also what scenario/trigger/catalyst will cause them to unwind and reverse their positions.
If you can understand the above, then you can understand almost every single situation and human behavior in the financial markets.
Order flow, information flow, macro, etc, can give you greater insight to help you size trades better. The reason is because you are analyzing the very foundations of the market and what really causes it to move. When you think of the markets in terms of a battle of macro scenarios, then all sorts of interesting situations can jump out. The tech ind/chart/price pattern trader struggles to know when to “Go For the Jugular” because the tools and strategy they use don’t really help them in determining if a monster trade is coming or not. All those fibs, stochastics, head and shoulders, etc, cannot really tell you whether the trade win rate is very high or low, or whether the reward and risk is high or low.
Macro analysis, interpretations of the information flow, playing out the battle of scenarios, and the concepts in the Mastery Course can all help you in figuring out when to Go For the Jugular or not.
Soros knew about these concepts and principles when he Broke the Bank of England. He and Druckenmiller did the macro analysis, battle of scenarios, interpreted the information flow for the situation at that moment in time and leveraged up their funds $3.3 billion capital, 3x to place a $10 billion short on the British Pound.
A pure trend follower or tech trader, would have never Gone For The Jugular, because the tools they use cannot help them in truly analyzing the very foundations of what causes the price to move. So they are reduced to only betting very small sizes all the time, struggling to know when a trade warrants a big size or not.
I combine all the sentiment, risk on, risk off, macro, scenarios all into the: news/sentiment/fundamental/macro players. That makes it easier for me. Risk appetite / Risk Aversion influences the sentiment/fund/macro players for various reasons. When you said that people are long USD/JPY and going long USD/JPY betting on a Fed taper and BoJ doing more QE, etc, that is all true. Risk on / risk off does influence those things, depending on the nature of why there is risk on/ risk off.
For example, over the last 2 weeks or so, USD/JPY was going down due to the debt battle in the U.S. It caused risk aversion, but not only that. The longer the debt battle lasts, the more economic damage it causes in the U.S. and that increases the likelihood that the Fed will keep delaying taper, thus causing more profit taking in USD/JPY as those macro buyers unwind their long trades. So USD/JPY was both going down because of some risk aversion causing general JPY bullishness, but also because of the change in expectations regarding the macro scenario of how fast the Fed will taper, etc.
I just combine everything into the news/sent/fund/macro players which will cause the volatility of the ODVE, MDMM and GM moves. That makes it easier for me to understand.
For structuring trades, I first ask myself: What is going to cause VOLATILITY to happen from the current moment. I try to make volatility first and foremost in my mind. Then I break it down into the various scenarios and countries that you mention that can cause volatility to happen. Which I analyze the recent news impacts and scenarios that have been moving the market. Then I go play out scenarios from the current moment. I say if this and this happens, then USD/JPY will probably move 100 pips, 300 pips, 500 pips. If this and this happens, this other currency pair will probably chop around, etc.
I try to do two forms of analysis: I try to look at each financial instrument individually and see if there is potential for a move due to a scenario specific to what is going on in that financial instrument. For example I may analyze EUR/USD and try to analyze the EUR and USD monetary policies and see if they can diverge or cause some volatility to happen. If I don’t see anything there, then I may do some general risk appetite / risk aversion analysis to see if there is an opportunity in EUR/USD. If I believe the risk appetite / risk aversion is not active in EUR/USD, then I will mostly not trade from a swing trade perspective. Then perhaps I may only place an intraday trade if I see one.
The second analysis is I like to compare things which each other. To try to find connections and correlations between various financial instruments and currencies, etc. This is in the Correlation Analysis / Sensitivity Analysis part of the daily habits. I try to find interested situations and anomalies and try to figure out whether to bet on the anomaly continuing, reversing, or doing nothing. I try to figure out whether I should “Go with the move”, “fade the move”, or do nothing.
For example the past week that just happened, Oct 6 – 11, there were a few different anomalies and shifting market sensitivity:
USD/JPY was acting with bearish sensitivity on Oct 7, as it was unable to sustain the bounces. I was long USD/JPY with a small size, so I had to figure out whether to take the loss, reduce risk, or just wait it out. But then on Oct 8, USD/JPY started acting with bullish sensitivity. The Nikkei and USD/JPY were roughly flat, while the S&P went down. So in this situation you would try to figure out whether to bet on the USD/JPY getting dragged down lower with S&P, or whether the resiliency of USD/JPY was an indication that it would start to go higher. I felt it was a bullish sensitivity, so I thought USD/JPY would bounce higher. Then for Oct 10, and Oct 11, Nikkei and USD/JPY kept acting with bullish sensitivity and were resilient to S&P selling. So that gave me confidence to stay with my USD/JPY long trade.
On Oct 8, bonds were acting terrible because while the S&P was falling, bonds could not make a fresh high, which told me that the safe haven bid in bonds macro scenario is getting kind of exhausted. On Oct 9, Bonds acted weak again as they hit the bottom of the congestion range, while the S&P were breaking lower.
On Oct 9, gold was acting weak even on a risk aversion day. If there is risk aversion, shouldn’t Gold try to go higher a bit on safe haven bid? Gold sold off a few days later.
On Oct 10, the CAD was acting weak as it fell on a risk appetite day. So I was trying to figure out whether I should short CAD or bet on it snapping back and rising in value. In the end I did nothing, as I could not find any clear macro scenario to bet on.
On Oct 11, there was a moment where the S&P was rising on risk appetite, but Bonds were rising as well, indicated another anomaly, as if the S&P is rising on risk appetite, then shouldn’t bonds go down on removal of safe haven bid? The bonds did eventually drop a bit into the close.
On Oct 11, Crude was acting weak as it fell, while S&P was going higher, but I did nothing because there are conflicting macro scenarios which can cause some choppy and weird action as the risk appetite macro buyers of Crude battle it out with any macro sellers from increasing Crude production.
So part of my job is to look at the whole world financial instruments and try to find these interesting shifting sensitivities and anomalies and see if there is a trading opportunity, of course never forgetting the principles of information flow, scenarios, news/sent/fund/macro players, etc.
I am not just looking for a situation where the market “acts right.” I want the market to “act right” with proper sensitivity, but also for there to be a catalyst for future volatility. When you can find a situation where the market “acts right” AND, there is a catalyst for future volatility in the direction the market is acting right, then that is where the really great trades happen.
As Michael Platt said in Hedge Fund Market Wizards:
There are three things you need to make money in a market. You need a decent fundamental story, a good trend that looks like it will carry on, and the market handling news the way you think it should.