Order Flow Trading Strategy

Order Flow Trading Strategy – What Is It? (Backtest Analysis Data and Insights)

For most retail traders, trading is mostly about technical analysis using trading indicators applied to a price to look at the current forces in the market. While technical indicators may play a significant role in trading, professional day traders don’t always depend on them. One of the most important tools in a professional trader’s toolbox is order flow. What are order flow trading strategies?

An order flow trading strategy is a method of trading that is based mainly on watching the flow of trading orders and the impact those have on the current price of an asset. With this strategy, the aim is to anticipate future price movement by analyzing the orders coming into the market. Trading based on order flow analysis will help you to see and understand how other traders are doing their trades.

In this post, we take a look at the order flow trading strategy. At the end of the article, we backtest the strategy.

What is order flow?

Order flow refers to the amount of limit buy and sell orders waiting to be executed at different price levels. As you may already know, every exchange maintains an electronic record of buy and sell limit orders that come in for any given instrument. You can see those orders on the DOM (depth of market) window of the exchange’s platform.

In the DOM window, also known as the order book, limit orders placed by traders are arranged by the exchange on a price-time priority, such that the best prices are kept at the top, as follows:

  • On the bid (buy limit orders) side, prices are arranged from highest to lowest and according to the time the orders came in.
  • On the ask (sell limit orders) side, prices are arranged from lowest to highest and according to time.

See the picture of the Binance order book for BTC/USDT below:

Order flow trading strategy
Order flow in bitcoin (BTC).

You can see the order book on the left side: the red numbers at the top are sell limit orders, arranged from the lowest ask prices to the highest, while the green numbers at the bottom are the buy limit orders arranged from the highest bid prices to the lowest.

With the right skills, you can learn a lot from a DOM (Depth of Market) window — the price ranges, what prices are attracting more or fewer traders, and so on. You can also see the disappearance of buyers or sellers at a certain price level, and with that, you can have a better overview of the correction movement in a trend.

Recommended Reading: Imbalance Trading Strategy

Watching the flow of trading orders and their subsequent impact on the price movement is called order flow analysis. In other words, order flow analysis allows you to see how other market participants are trading (buying or selling) and how their activities move the price.

An order flow chart will show you exactly how many buy and sell market orders were executed at each price level. Analyzing the order flow helps you recognize the final details of the buying and selling volume. It’s a microscopic look into the price movement that is represented on the price bar or candlestick.

The order can show supply and demand imbalances. So, by watching the changes in order flow, you can see the imbalance and be able to predict short-term price changes. If you are a day trader or a scalper, you can trade based on the limit order books by tracking the order flow.

For example, if huge sell orders are coming in at lower prices, and no corresponding volume is coming on the buy side or they are coming at lower prices, there’s a huge chance the price would drop.

What is an order flow trading strategy?

Order Flow Trading

An order flow trading strategy is a trading method based mainly on watching the flow of trading orders and the impact those have on the current price of an asset. It is one more tool used by professional traders in addition to other popular forms of market/trading analysis such as technical analysis, sentiment analysis, and fundamental analysis. Order flow trading is sometimes referred to as a form of volume trading because it is based on the volume of orders coming into the market.

Better than the other forms of analysis for short-term trading, order flow analysis can help you predict with a good amount of certainty where an order imbalance awaits at a future price level. This can allow you to enter the market with precision and more confidence. The order flow trading strategy aims to anticipate future price movement by analyzing the orders coming into the market. Trading based on order flow analysis will help you to see and understand how other traders are doing their trades.

The order flow chart will show us exactly how many buy and sell orders are happening in the market at each price level. By watching the Order Book and also footprint charts, you see the subsequent impact on the price of the market by these orders and therefore make predictions on the future price and direction of the market. If you are a short-term trader, such as a scalper or day trader, you can use the order flow analysis to enter the market accurately based on recently executed buy and sell orders.

Order flow analysis allows you to see what types of orders are being placed at a certain time in the market. For example, you can see the amount of buy and sell orders at a given price point and be able to determine which side the balance tips. Here is the thing: when the price is rising upward in a very strong rally, you would know for certain that it will eventually stop somewhere. The rally happens because there are fewer sell orders and more buy orders, making the upside the part of the least resistance. With more traders willing to buy than traders that are willing to sell, there is an imbalance between buyers and sellers.

That is, there are more buyers demanding the supply, so the price shifts upwards. The upward movement continues until it gets to a level where there are huge sell orders to absolve all the buy orders, creating a supply surplus. This new imbalance created by more sellers than buyers will push the price downwards. A skillful order flow trader can spot those key price levels with order flow imbalance and trade from such levels. Analyzing price movements with order flow is a game changer for professional day traders.

What is the best order flow indicator?

Order flow consists of price, time, and volume factors. Considering one and leaving the others wouldn’t make sense. If you make decisions solely based on price movements within a specific period without considering the current volume, you are missing a crucial element of the game. In the same way, tracking the volume of the occurring trades, without analyzing price movement in relation to time, gives you no indication of the direction. And the significance of time in trading is best defined by the volume that drives prices. So, they are all linked together.

Thus, the best order flow indicator must show price movement in time with the volume driving the movement. There are many order flow indicators, but some of the best ones are as follows:

Footprint charts

Footprint charts come in several different variations, such as the Bid/Ask footprint chart, which displays all market orders that traded on the bid and the ask for every price level, and the Volume Delta, which measures the difference between buying and selling power. The Volume Delta is calculated by taking the difference between the volume traded at the offer price and the volume traded at the bid price. It allows you to gauge the strength of a move by analyzing the aggression of buyers and sellers by their use of market orders.

Order flow trading strategy (footprint chart)

Volume profile

This unique charting tool enables traders to observe the two-way auction bidding that drives price movements in a way that reveals patterns in herd behavior. The volume profile shows the dispersion of trading volume over price during a specific time range. It can be used to pinpoint important support and resistance levels.

Order flow trading strategy (volume profile)

Time and Sales Window

This is a sort of running record of trades. It displays every trade by its transaction time, volume, and price. The Time and Sales Window is considered the high-tech version of the old ticker tape, offering more speed and volume capabilities. It allows you to find substantial-sized trades that may reveal significant shifts in buying or selling pressure. You will have to scan the data visually, but if you master the skill, you can gain an advantage over other traders.

Order flow strategy (time and sales)

Level II or Depth of Market (DOM)

This displays the limit buy and sell orders that come into the market. You can use it to analyze areas of high and low liquidity in the order book as well as to evaluate the aggression of buyers and sellers. This is often known as reading the tape. It takes experience to master.

Order flow strategy (level 2)

VWAP Indicator

VWAP is the short form for volume-weighted average price, which means a security’s “average price” based on both volume and price. It is often used by institutional traders to know the right price to buy or sell. It gives them an idea of liquidity and the average price to target when getting into a position.

Institutional traders will often buy when the asset price is below the average price and sell when the asset price is above the average price. And they use the VWAP to determine where asset prices are relative to average prices. So, you also use the indicator to increase the odds that you might end up trading with and not against the larger funds.

order flow trading strategy (VWAP)

Money Flow Index

The Money Flow Index is a bit similar to the RSI indicator but has added volume into the mix. We have covered the indicator in another article. When we backtested it, the results were pretty impressive:

Can you use order flow on stocks?

Of course, you can. Order flow analysis is best used in markets that have a central exchange, and stocks fit into that description. In fact, the best market to trade with an order flow trading strategy is the stock market. And the reason is that it has a central exchange that keeps a record of all orders that come in for any instrument. See an example in the picture below, which is an order book for Nasdaq, Inc (Nasdaq: NDAQ):

Order flow strategy on stocks

Apart from stocks, other markets where you can use the order flow strategy include the commodity market and cryptocurrency. An order flow strategy may not work well in forex trading because there are no exchanges but brokers and their liquidity providers.

Order flow trading software

Essential Order Flow Tools

An order flow trading software is a trading or charting platform that displays order flow indicators, like Time and Sales and Level II data (Depth of Market or DOM). However, not many platforms come with advanced tools, such as footprint charts, delta, and volume profiles. To get those advanced order flow tools, you may have to get a third-party add-on which you will have to pay extra for. Having said that, these are some of the common order flow trading software:

  • MotiveWave: This platform offers the most complete charting packages for order flow traders who want to trade different markets, and the software can run on several operating systems including Windows, Mac, and Linux.
  • Ninja Trader: This is a popular trading platform among derivative traders and one of the most popular charting platforms for algorithmic trading. It is lightweight and fast which makes it ideal for scalpers or day traders. It has a well-thought-out DOM (depth of market) that includes volume profiles; however, a lot of important order flow indicators only come as third-party add-ons.
  • Sierra Charts: This charting platform offers a strong order flow package including footprint charts (number bars) and volume delta. It allows endless customization.
  • ATAS (Advanced Trading Analytical Software): This is an analytical platform designed for order flow analysis. It offers Time and Sales, Level II data (Depth of Market or DOM), and HFT algorithms tracking.
  • Exo Charts: This platform focuses solely on crypto markets. It has decent order flow tools for analyzing crypto price movements.

Order flow trading strategy backtest

To backtest an order flow trading strategy is no easy task because of the dynamics in the order flow. Also, we suspect most (if not all) independent order flow traders are not using backtested or quantified strategies.

However, we would like to show you a different method indirectly based on order flow. It’s a strategy used for many decades on the New York Stock Exchange (NYSE). Let’s explain:

It’s based on the opening and closing “auctions” that occur daily. NYSE is still using them:

The two auctions are based on order flow. If there are more sellers than buyers, the price will open further down compared to if it was more buyers.

Opposite, a buy imbalance might send the price up. The reason is that the designated market maker (formerly called a “specialist”) will fill the orders as low or high as possible to make money. Open only orders
(OPG) are normally sent before the opening at 0930 local time (and before the close at 1600 local time).

This is how it works:

Let’s assume PG (Procter & Gamble) closed at 100 yesterday. Today a big sell order enters the order book before the opening, and your buy order at 99 might get filled at 98. Thus, you get a one-dollar price improvement.

Sometimes, you get an easy gain by putting buy and sell orders away from the “fair value”. Fair value is, as you might guess, not a fact. However, we traded such a strategy very profitably for over a decade, but unfortunately, the easy prey is gone.

Below is an order flow strategy backtest based on the opening print:

Order flow day trading strategy backtest

Let’s look more closely at this:

We are looking at Pepsi-Cola (PEP) and how it opens compared to XLP. XLP is the main index/ETF that tracks consumer staples. We make the following trading rules:

  • If PEP opens 0.4% LOWER than XLP, we buy the open and sell at the close
  • If PEP opens 0.4% HIGHER than XLP, we short the open and cover at the close

Of course, there are two problems with this strategy. First, we don’t know where XLP will open. The orders in PEP must be sent before the open; thus, we must use some approximation.

Let’s look at the chart to see how PEP typically opens compared to XLP:

Order Flow trading strategy backtest

The lower pane shows the difference between the opening price of XLP (red line) and PEP (blue line). Most of the time, we can see that both XLP and PEP open more or less at the same level but sometimes deviate from each other. When the blue line is higher than the red line, it signals that PEP opened higher than XLP and vice versa.

How much higher and lower should the entry price be compared to XLP? If we use a 0.4% envelope, we get the following equity curve:

Order flow strategy trading rules

There are 1760 trades (56% long trades), and the average gain is 0.22%. Long is better than short: 0.28% vs. 0.14%. The annual return is a solid 17%, but the max drawdown is relatively high at 29%.

The backtest we have done in this article might be inaccurate because the opening price in the dataset might be wrong. You should use NYSE data when you backtest this strategy to ensure the result replicates the backtest.

Furthermore, we are including days when there might be significant news in PEP. Our experience after trading strategies like this is that news days are poor. We don’t trade such days.

The exit in our backtest is at the close, which might not be optimal. We also use XLP to determine the open, which might be unreasonable. As always, you must do your due diligence!

List of trading strategies

We have written over 1200 articles on this blog since we started in 2012. Many articles contain specific trading rules that can be backtested for profitability and performance metrics.

The trading rules are compiled into a package where you can purchase all of them (recommended) or just a few of your choice. We have hundreds of trading ideas in the compilation. The code for the order flow trading strategy is included in the package.

The strategies are taken from our landing page, where you can find any basic trading strategy.

The strategies also come with logic in plain English (plain English is for Python trading and backtesting).

For a list of the strategies we have made, please click on the green banner:

These strategies must not be misunderstood for the premium strategies that we charge a fee for:


How does order flow analysis work?

Order flow analysis involves observing the amount of limit buy and sell orders at different price levels, as displayed in the depth of market (DOM) or order book. Traders analyze these orders to identify supply and demand imbalances, predicting short-term price changes.

What is the significance of the order book in trading?

The order book, or depth of market (DOM), displays limit buy and sell orders arranged by price levels. Traders use this information to gauge market sentiment, identify price ranges, and anticipate potential price movements based on the order flow.

How does order flow analysis help in trading decisions?

Order flow analysis provides insights into how other market participants are trading, helping traders make informed decisions. By understanding the flow of orders, traders can anticipate market trends, recognize imbalances, and predict short-term price changes.

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