a guide to order flow

Crypto enthusiasts might hear terms like “market depth” or “liquidity pool” and think they mean almost the same thing; these terms are used loosely throughout trading circles within the crypto community. Other terms like retail trader, institutional trading and stop-hunts all start to make sense once “order flow” is understood.

In trading, there are different types of orders with different implications, but once a few basic concepts are understood, jargon finds its right place and the markets are easy to understand.

Order Flow Defined

Order flow is simply the market in action. It is the constant buying and selling, and the points pegged at which traders enter and exit. It’s also what determines price, essentially the constant flux of the market as buyers and sellers seek equilibrium. A fundamental tesnet of order flow is that there must be a buyer for a seller. Sellers are market makers and buyers are market takers.

If a buyer enters the market and finds there are no sellers at the desired price, they typically place a “limit buy order,” which simply means that when and if the price of the asset reaches the price the buyer wanted to buy in at, the buy order is then executed. The purchase happens.

Similarly, a limit sell order works the same way for sellers, starting with the top of the order book. Once the price hits what sellers have booked as sell orders, sales are executed from the top of an order book down.

Slippage Happens

Any retail trader can log into any one of a number of exchanges and buy, for example, some Bitcoin, taking prevailing market price. The difference between what that trader buys at and ends up paying is termed “slippage”.

It can be confusing, as the market also talks of “trading without slippage,” and slippage is sometimes also used to describe the opposite of its negative implications, much like the word “sanction.”

Basically, slippage happens when a trader takes a buy and ends up paying more than prevailing figures indicate. This is a frequent occurrence in highly volatile markets, and cryptos are the wildest assets anyone has seen for a long time. Particularly institutional investors and whales are prone to extensive slippage at times.

Slippage is the difference between the price (and ultimately cost) a trader was expecting to sell (or buy) at, and the price at which they had their position filled. Assume an institutional investor has a large open order to sell when the price hits X. The X price comes around and the order begins to execute.

Because of the structure of order books, that order will commence at the desired price, but as it eats its way through the “page” the price keeps changing (falling) and the order execution doesn’t happen at the desired price. This is slippage in action. The investor might have started selling at $7000, but takes $6500 midway and $6300 as a final price to complete the whole, large order.

The worst aspect to slippage is that it doesn’t present as “linear.” In other words, if the total loss or slippage on price of the hypothetical order above was $10,000, depending on market volumes traded, it can in effect be a lot higher. This is where liquidity comes in as a hedge against slippage, for big order books.

Liquidity Saves

Reports often refer to institutional or even dedicated retail investors seeking “liquidity” before trading. More than a snobbish association, liquidity is an essential aspect for larger investors particularly.

In a nutshell, liquidity of an asset defines how much of the asset can be sold without affecting the price. Hence bitcoin, ethereum, EOS and bitcoin cash are the most liquid digital assets. Liquid assets like these can generate what are known as “futures markets” that allow for both long (believing the asset will hike in price) and short (believing the asset price will fall) positions. Lower market cap altcoins cannot be traded in this way, as their liquidity simply isn’t there.

Liquidity pools are zones where institutions seek to enter a short position,needing many longs in the market. Likewise, an institutional long position demands that there are many shorts in the market concerned. This tends to mean that these institutions enter the market facing the opposite direction, contrary to prevailing market sentiment. These “zones” where big ticket traders find lots of limit orders and stop-losses are called liquidity pools.

Stop-hunts’ Impact

Execution of liquidations (voluntary relinquishing of a position) and stop-losses (the set-up trigger where a position closes, based on price) provides the market with liquidity. Utilizing this liquidity to fill the opposite position by forcing it is called a stop-hunt, and it can also happen when big traders simply want to fuel a rally.

Stop hunting is a strategy geared towards forcing some of a market’s participants out, by pushing the price to a point where a lot of individuals have set stop-loss orders. Stop-hunts can sometimes be obvious and visible cases of market manipulation, as the whales who engineer artificial demand or supply tend to leave their fingerprints behind.

Retail Trading Approaches

New crypto traders often first learn of support and resistance, support being where a decline in price stops and resistance being where a rise in price curtails. They also often gain the correlation of going long at support (as the price should rise) and short at resistance (as the price should drop at least a little).

Traders also learn that a “break of support” implies market reversal and adjust positions accordingly. These market entries, targets or stop-losses (set to protect trades from wholesale loss) are highly predictable and are therefore easily abused by institutional big hitters. There are various technical patterns to be familiarized too, such as “pennants” or flags (indicating a continuing trend) and “head and shoulders,” typically a precursor to a dip in price.

There are literally thousands of textbook guides that together form the book of knowledge of retail traders. Because their trading thus mostly follows textbook definition, institutional investors find liquid zones peopled with retail investors very attractive, as movements tend to be predictable for their game.

Market Terms Conclusion

Although far from exhaustive, the few terms explained above are essential for any newcomer to crypto trading to understand. When “order flow” is understood alongside these key terms, the daily market movement becomes familiar and understandable.

Newcomers quickly learn to spot market manipulation, although it remains difficult for any one trader to know absolutely which way things are going. An appraisal and understanding of these key aspect of market trading are employed to formulate a reduced-risk approach to trading, one with lower risk and greater prospects for profits, based on technical and fundamental analysis.

Not all liquidity pools are full of crocodiles, but newcomers need to be aware that active engineering of markets for a profit – no matter anyone else’s expense – is not only legal, but standard institutional practice. With the passing of time, traders learn to recognize a set-up when it’s happening, based on the recent history of the pool and other indicators. Such honed skills are easy to grasp, but really only develop with experience of active markets on a daily basis.

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