Order Flow Tool cheatsheet

What`s this all about?

The basic idea of the model is wrapped around ES futures transactions and orders flow data (time and sales + orderbook or active and passive tradeing flow). Its aim is to filter out significant events which are clearly bullish or bearish, categorize, score and quantify them in form of indicators which you can see in the lower section of orderflow chart. These two indicators (momo1 and momo2) are the core of the model. 

The more events occure and are identified as bullish you will see higher readings – opposite will happen when there is more bearish events.

As observed, these bullish/bearish flows are mean reverting, not perfectly corelated with price data and not always corelated with each other (for example you can see bullish orderbook while transactions bearish). It apears as significant bullish/bearish flows act in two distinct modes of operation and resamble classic accumulation/distribution patterns which seems as a sound theory but hard to apply in real-world without rule-based and quantifiable metrics. These two modes of operation are going to be discussed further and in detail below.

Based on the model we can descern three phases of market state: reversion, trend forming and trending. It is worth noting that these three phases are not always clearly visible through price action, for example the model can show forming of new bullish trend while price is making new lows from price action perspective. That is why one can argue that m1 and m2 indicators are not trend or countertrend tool as they apear to cope with both states of market effectively.

Beside these three major stages we can observe at least two more, less important – but still significant – phenomena which I will discuss later. 

As of writing this paper, it is true that given certain money management set of conditions, the strategies based on this model did not produce loosing transactions. But as good as it sounds one should not apply these strategies without proper risk valuation and the perspective that this kind of advantage will last forever – which is quite literally impossible.

What am I looking at?

  1. ES_F price, 15 minut periods.
  2. Volatility bands (bands) – price levels based on implied volatility, used for trade location in adequate conditions. 
  3. Horizontal levels (horizontals) – price zones based on structure and volatility, used for trade location in adequate conditions.
  4. Orderbook Momentum (momo1/m1) – bullish/bearish activity on orderbook – passive traders.
  5. Time&Sales Momentum (momo2/m2) – bullish/bearish activity on transactions – active traders.
  6. Thresholds (+400/0/-400) – major momentum levels.
  7. Dots (green momodot or red momodot) – marked at the event of both momo1 and momo2 above +400 level (red dot) or below -400 level (green dot).
  8. Optimal horizontal level – a midpoint inside of horizontal levels zone.
  9. Small green/red dot – marks an event when momo2 is below/above -400/400 and price below green bands or above red bands (not used in main setups).

The trend cycle (momo2 trend strategy)

Bullish trend forming as seen through momo2 perspective is identified through a sequence of events which can be described as follows (bearish trend formation is 100% opposite): 

1 . momo2 reaches +400 or higher for the first time after it was -400 or lower. This is very important (“the first time”) as we want to be as close to the beginning of new bullish trend as possible. What happens here is major bullish flow attempts to take control over market and actually marks it by reaching +400 level – the weight and number of bullish events is overwhelming. But because such effort is usually very consuming we must expect bullish pressure to get lighter at that point. This is when we expect price to retrace and depending if we have red momodot at that point or not we can expect how deep the pull-back is going to be. (red/green momodot will be explained in separate paragraph). This step is also called “Last move down before bullish trend sets”. So in essence although we know bulls took control of the flow we expect one more leg down and if we are in a short position we still hold to it until step 2.

2. In that step we try to locate entry for our long position or in other words we want to gauge how far the pullback is possibly going to be. Now, at this point there are couple important things to be noted. There are three different key things to watch. The very raw and simple take on it would be just to start buying when momo2 is getting close to 0 (zero) level. And that is fine but you have to be prepared to add to the position or just have wider stop loss.

If we would want to be more precise (but possibly less entries), there are few things to note here before getting in the trade.
First thing is where are we from the perspective of bands. The optimal entry always would be in the lower bands levels (at least lower grey band for longs). That allows to enter the market with least risk. Now, can we gauge if its better to enter the market before hitting grey band? About 90% of time yes. If at the peak point of momo2 after it broke through +400 momo1 was divergind in -400 area we can expect deeper pullback before longs will take off. Its because there was no balance between orderbook and transactions and its very possible that market will drop more agressively and deeper.

The same situation happens when at the Step 1, so when momo2 gets for the first time to +400 we get red momodot (both momo1 and momo2 are above +400). In this situation we expect market to pull back to lower grey bands or very close to it. And so entering long when momo2 gets back to zero after we had red dot usually will be too early as “dot setup” which will be disccused later rarely misess its target which is at grey band.

To sum it up, what we see here is simple 2 step trend forming pattern: bulls take control which is indicated by momo2 above +400 for the first time after it was in bearish trend (momo2 below -400) and lastly a pullback in flow dynamics making momo2 retrace to 0 (zero) area. Also we learned that the least amount of risk is at lower grey bands especially after momo divergence or red dot.

Exiting or reversing momo trend trade. There are three main factors which determine the exit from the trade. First, the obvious one would be oposite setup, so momo2 dropping to -400 and then back to 0 (zero) -> reverse from long to short. 

Second type of exit is Red Dot Entry setup (for exiting longs or Green Dot Entry setup for exiting from short position). It is very important: Im not talking here about red or green dot apearing. The dot itself is just a marker, Dot Entry which im talking about here will be discussed in the next paragraphs, but it is important for now to remember that Dot Entry means exiting from momo trend trade.

Lastly there is something what i call pre-exit and is simply based on the fact that statisticaly after momo2 gets to lets say +400 for the first time it will usaully retrace, hit +400 again, retrace and hit +400 for the last time. So basically its a cycle of 3 and sometimes 4. I would usually take part of my position out after hitting +400 (when long) or -400 (when short) for the third or fourth time.

Reversion or MomoDot strategy.

This setup which was mentioned in the first part is much simpler to understand, I think, and rather straight forward. It needs to have three conditions met to actually allow us to initiate trade. 

  1. momo2 and momo1 are above +400 (for short setup) which will be marked on charts with red dot.
  2. momo1 needs to be below momo2 – so we know that there is actually some bearish sign of action in orderbook.
  3. price has to get at least to upper grey band. Now the important thing is that we dont need step 3 to be at the same time as step 1 and 2. Once the dot is marked on chart but price is lower than higher grey band, that setup is still active and should be initiated when price gets to higher grey band. 

Above three steps are momoDot entries mentioned in the first section. So if we get actual entry from momoDot strategy it means we have to close our momo trend positions as these will be always opposite to momoDot.

Once we initiate trade, our target is at least on the opposite grey band. Important: if target is met before we have a chance to get in the trade at higher grey band, the setup is deactivated and no longer valid. This is very important. Few examples below:

to be continued…