How To Use Order Flow In Order To Get A Daytrading Edge

I have spent the majority of the last twenty years in the business as a NASDAQ market maker and before that as a buy side trader for a large group of mutual funds. The bulk of my trading experience is from a different perspective than a lot of you have probably seen. As a buy side trader I was working orders you were trying to sniff out and as a market maker I was probably on the other side of many of your trades (for better or worse). In writing for TradingMarkets, I would like to share with you some of my experiences from the heat of the battle with money and emotions on the line.

As a market maker you have the luxury of knowing where the buyers and sellers live in a select group of stocks and the ability to interact with order flow throughout the course of the trading day. You have the knowledge of your customer’s prior activity at various price levels and indications of interest at different price points. You also see who the buyers and sellers are. Not all buyers and sellers are created equal. There are those customers you never want to take the other side of a trade with and will want to follow for direction. Back in the bubble days it wasn’t fun having a bad short in some $200 stock only to have one of these guys walk in the door as a buyer but at least you knew it was time to go buy some stock. On the flip side of that was being long when such a buyer surfaced. There is nothing like order flow to help guide you through the day. When trading without the benefit of order flow tape reading skills and market feel become more important. When something is setting up at an important level keep your eyes out for volume along with some size coming in on both sides of the market and what happens when it does. There is usually something happening to help lead you in the right direction whether it be volume or simply the appearance of buyers or sellers on the screen. Take a look at a recent example of a 2 dollar number.



Capstone Turbine (CPST | Quote | Chart | News | PowerRating) broke out above resistance on 8/1. There were clues before this happened. Volume was picking up with bids showing at various levels. When the sellers took out the bids even more bids entered the market and by days end this stock was off to the races.
With the improvement in technology and ECNs getting so much of the volume it has become much more difficult to track some of the bigger market makers but keep an eye on which ECNs are involved. Some of the big boys use the same machine with the same buy or sell amount every time they enter an order.

In addition to tape reading which is an available option for all proprietary traders you can find additional ways to give yourself an edge unavailable to most. A prime example would be a model driven system to help create an edge much like order flow created the edge I had for many years as a market maker. The Connors Research Group has some great statistically backed strategies which will put you in a trade while knowing in advance what you will do depending on the circumstances surrounding the trade. Of course this can only give you a statistical edge, if there is a big order out there on the other side, you lose but you have the confidence of trading with probability on your side. It happens but as long as you are prepared it’s no problem, move on the next trade. There are many opportunities out there to be taken advantage of.

Like I said earlier I have been sitting on trading desks for majority of the last 20 years so my writing skills might need a little work. I look forward to sharing my trading insights with you.