Order Flow

What order flow measures

Every trade has a buyer and a seller. The side that is in a hurry takes the price the other side is offering. A buyer in a hurry pays the ask, and a seller in a hurry accepts the bid. Order flow counts the volume on each side. Where the tape gives the side of each trade, it can be counted directly. Where it does not, tools estimate it from whether a trade printed nearer the ask or the bid, and the estimate is rougher.

A worked example, one price ladder

Take one bar with five price levels. At each level the volume that traded at the ask and at the bid is shown, and the delta is the difference.

The bar traded 3,440 in all, with 1,960 on the buy side and 1,480 on the sell side, so the delta of the bar is +480. Look at the shape: sellers dominated the high prices at 100.4 and 100.3, and buyers dominated the low prices at 100.1 and 100.0. That is the kind of picture a trader reads as a fight at each level. It is also only one bar, and these volumes are made up.

Cumulative delta and the divergence

Over six made-up bars the price closed higher on 4 of 5 moves. The cumulative delta did not rise every bar: it went +480, +1,160, +920, +1,780, +1,260, +1,410. On bar 5 the price closed higher with a delta of -520: buyers did not drive that move. Traders call this a divergence and treat it as a warning. It is a talking point, not proof.

Absorption, a common reading

Look back at the ladder. At the lowest level, 100.0, buyers took 410 against 130 sold, and the bar went no lower than that. Traders call this absorption: heavy one sided volume at a level where the price stops, read as the other side quietly taking the flow. The same picture can also just be a level where a lot happened. Two people can read one ladder two ways, which is why a rule built on it must be written exactly and tested, not judged by eye.

What goes wrong for a bot

• Data quality. The side of each trade may be guessed, and a feed that drops ticks changes the delta. A test on clean historical ticks can overstate what a live feed gives.
• Volume is not the whole market. In markets that trade on many venues, one feed shows only part of the volume. Spot currencies have no single central volume, so the figures mean less.
• Speed. Order flow signals are short term, so a rule trades often and pays the spread and slippage many times. See algorithmic trading for how speed multiplies cost.
• Many settings. Bar size, thresholds and look back windows can be tuned until the past looks perfect, which is overfitting.
• Look-ahead. Reading the delta of a bar before it has closed uses information the bot would not have had. See look-ahead bias.

How to check a rule that uses it

Write the rule in words with every threshold, test on tick data with full costs, count the trades and keep data back for one final test, as in backtesting. Then run it in paper trading to see whether live feed delta matches the test. Look at the max drawdown, not only the profit.

What this page does not tell you

It does not say that order flow gives an edge. It shows how the numbers are made. The volumes are made up and this is education, not a signal.