One thing that I have learned over the years is that there’s order flow, and then there’s ORDER FLOW.
The distinction between the two comes from the fact that not all market’s Order Flows are created equally. As there are such deep structural difference amongst different types of markets (e.g. – FX, Equities, Futures), some markets are better than others for extracting actionable intelligence.
Here’s my take on 3 substantial markets from 30,000 feet and from within an electron microscope.
Forex is Dealer Market. This means that order flow interpretation algos must read aggregated order flow, which is at best, splintered, lagging and has holes.
Thus, order flow monitoring algos suck wind in FX.
Because of HFT there is lots of erroneous information generated that must be processed by your order flow algorithms.
Furthermore, due to the uber-decimalization of prices, equity information is overly sliced. This over-slicing reduces the ability to deduce ‘intent’ and future direction.
Thus, order flow monitoring algos suck wind in equities.
You may have noted that our company is called ‘Algo Futures’ so let me state right off the bat that I am biased towards electronic futures.
….but our focus on futures came after a ton of research pointed us in this direction.
Thus, we did not start out with this bias…it was learned over the course of many years, oodles of order flow monitoring software development, and countless sprints of focus to understand and interpret the output of our order flow algorithms.
One great thing about futures is that they trade on one exchange (for most products). Attaching order flow monitoring algorithms to one exchange (a single source for data) not only makes reading data easier, it makes the data more ‘whole’.
Another great reason to focus on futures is that they maintain a massive and stable bid\ask spread (e.g. $12.50 bid\ask spread in ES – S$P 500 e-Mini).
This massive bid\ask spread creates an environment where order flow’s ‘intent’ is forced to be quite obvious. And understanding the ‘intent’ of Order Flow, is the art and science that can underpin the profitability for a small software\trading company like ours
The downside to the futures market’s gargantuan bid\ask spread is that this bid\ask spread has to be overcome before a trade can become profitable…and depending upon the frequency of your trading, this can become a substantial overhead.
Note - We have spent lots of time developing algos to help us overcome the bid\ask spread in the futures markets. We now have the ability to enter all of our trades at the market, thereby paying full-freight, and still be profitable.
Finally, some futures markets actually have customers that need the underlying commodity. This may come as a shocking surprise to some, but not everyone who trades is a speculator…some markets are heavily influenced by the real demand created by hedgers as opposed to the frenetic demand created by speculators.
For instance, Crude Oil’s tape, IMHO, is more ‘sincere‘ than other markets because people actually need Crude Oil.
Hence the Crude tape often reflects real Supply & Demand…which is the easiest order flow to interpret and to piggy-back.
Some more thoughts in this here:
Hope that you find this stuff as interesting as I do…