Order Flow Scenario Analysis II
Posted on March 15, 2011 on ForexFactory
Originally Posted byÂ xXTrizzleXx“Hey guys,
My latest mental excursion is the product of a foray into Market Logic,Â grkfx’s suggestion of placing our stop losses in areas where they are likely to beÂ rescued by the orders of other participants, and one ofÂ Darkstar’s old charts where he was trading AUD/USD in anticipation of an interest rate hike, which reminds me very much of the current situation with EUR/USD.”
Thats good thinking! Deep thinking and different scenario analysis are very important and you are developing great skills.
Just a few thoughts of mine.
Just as you say a primary scenario is overtaken by a second newer temporary scenario, that second scenario can be overtaken even more temporarily by a third scenario as well. That happens sometimes as well. I don’t want to over complicate things, but don’t assume the market is rigid and only has a primary and secondary scenario. Every time you do deep thinking and scenario analysis you need to be completely flexible and take into account a lot of different potential options. Yes some may be far fetched, or have a low probability of occurring, but you still keep them in the back of your mind, so that when they do occur, you can take advantage of them, or cut your losses, so you do not take unnecessary losses.
How many people you think had done deep scenario analysis for the Japan earthquake scenario? I guarantee you most traders did not. Maybe even many order flow traders did not do that deep analysis as well. If you do the work, the research, the deep thinking, the thinking about the fundamental value can be affected, how the liquidity situation/distribution will be affected, how stop orders are affected, how other players will adjust their orders to various situations, that is a killer edge.
I also guarantee you many traders will be caught off guard the next time another earthquake/crisis/shock to the market hits, because most human beings forget about things and don’t learn their mistakes. That is how it always is and how it always will be. Do the work, develop the right habits, constantly push yourself and join the group of people who take their money.
Value traders are great. They can provide great limit orders to soak up a lot of liquidity and take the brunt of the market’s momentum. They can even execute market orders too, if they find prices very attractive.
But even value traders require aggressive order flow from other market participants, or other value traders in order to push prices in their favor. In other words they require other market participants and value traders to be willing to execute market orders further and further away from your entry price. They need to be willing to accept worse and worse pricing, or something else to cause them to be gladly willing to accept those prices.
As for what happens if the level at which the value traders get overwhelmed. Well value traders sometimes can scale in. If they have a massive position to put on, they prefer to scale in (unless something else makes them do it in a hurry), or even if they have a mediocre position , due to the nature of their trades and them willing to potentially absorb many hundred pip drawdowns, they can scale in with those as well.
That is where the value traders would be smart to use the intra day inefficiencies to time their trades better. Although many of them do not, people are just not that efficient.
The first and foremost risk control measure is not the placing of the stop losses in areas where they will be rescued. The best risk control measure (besides not placing a trade) is to ensure that your entry is as close as possible to the high/low that you are trying to catch. You try to make sure that once you get your entry that there will be massive order flow, so that your stop loss is never threatened, and that it would be crazy and suicidal for other market participants to try to take them out. So you should always be striving for the ideal of catching the high/low to the pip. Yeah, yeah I know it’s hard but you should be striving for it as you may develop interesting new strategies and techniques to help you out. That is where placing trades that are impossible to lose come into play.
Obviously not all market highs/lows are the V shaped spike highs/lows. The ideal situation for value traders would be a rounded high/low where the market stays or retests the level on several occasions, providing them ample liquidity to get in a large order. The V shaped spike highs/lows are great too, but they may not be able to get in a large enough order due to the fact that the market may only spend only one day at those exaggerated prices and they cannot get in a big enough order and they do not want to chase the market.
Value traders have pain tolerance points as well, and they do get hit at many different times during the year, where they need to unwind their positions. Sometimes when certain value traders are unwinding their positions, the people providing liquidity to them are the more skilled value traders who are getting in at a better price.
There are just so many different scenarios and possibilities, but you should think about them all! It’s information overload in the beginning for sure, but you will eventually figure it out.
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