Changes In Order Flow Precede Changes in Price
I have this pet theory that is built upon the Eco 101 concept that all changes in price are predicated on changes in supply and demand – regardless of the market.
Thus, if you could monitor changes in supply in demand for crude oil futures or S&P 500 futures, you would be able to more quickly determine the likelihood of a change in price.
As these markets have shifted from being transacted in trading pits to servers in data-centers, in my mind, it makes sense to point some software at the transactional data being published by these servers, and then simply jump into the market when the software notices changes in supply and demand that meet certain threshold levels.
Price Momentum Algorithms Are Always Lagging Price
Currently, a lot of folks, well at least hedge funds and prop trading companies, build trading systems based on changes in Price Momentum.
The challenge here is that since changes in price momentum cannot be calculated until after there has already been a change in price, their momentum output is always lagging changes in price.
Wouldn’t it be better to calculate changes in the momentum of the factors that change price, i.e. -Supply & Demand?
Wouldn’t this then offer you an indicator the leads changes in price instead of lagging it?
Wouldn’t this give you the possibility of a trade entry with a better price as you could know in real-time that at any moment price was likely to change at a rate that was significant enough to provide a profitable trade?
In a nutshell, using order flow momentum information as opposed to price momentum information, implies that you have an opportunity to glimpse into changes in price before price actually changes, as opposed using standard momentum indicators to give you a heads up after price has already changed.
Software Tuned For Monitoring & Analyzing Order Flow
We develop tools which track the footprints left behind by these Buy/Sell programs and profit from the information they provide us. We monitor the details of every transaction taking place in an effort to identify situations which have a high probability of producing a positive trade setup. It allows us to monitor when and where the machines that drive the Flow are at play, when they are not, and what that means to the market landscape at present time.
The output of this exercise provides us opportunities to harvest from short term directional price action by making trades when the action of the overwhelming Order Flow differs from the action of the market, or strongly confirms its directional movement.
The WOW Index
The WOW Index (Weiss Order Weighted Index) is a Weighted Index that is built from information derived from each and every Order within a market.
We are currently publishing the WOW Index for the SP 500, Dow 30, STOXX 50, and Crude Oil futures markets on this site as a free service.
Hope that this helps your trading.