YWS AMA Volume 1: Collective Psychology, Price Action & Order flow
Welcome back to the readers of my first and second articles introducing the basic principles of volume profile and market symmetry (and hello to first-time readers). In this third installment, I have decided to take the most common questions that I come across and dive deep into them. As the title of this article suggests, market psychology, price action, and order flow analysis are undoubtedly the most consistent questions I get about trading.
For some reason, it seems as though many traders focus solely on the order book and not the actual trades themselves, which in my opinion, is a big mistake. I am not saying that following hot spots on the order book isn’t a good idea (to some degree), but I’ve noticed many people lamenting endlessly about buy and sell “walls” without really understanding the games that larger size traders and market makers play in order to affect our psychology. One of the most important aspects of trading is understanding the motives (psychology) of all market participants. This leads me to our featured question, which covers all of these topics: How can you tell when there is a confirmed long/short situation vs a fake-out?
This question is the definition of loaded. However, there are ways to assess each setup, deduce what the outcomes could be, and rank them in terms of their probability of occurrence. Many veteran traders call these “hypos’’ and usually have at least two (sometimes three or more) scenarios that could unfold given a setup. Let’s get back to the order book complex that many traders seem to have. If you use Cignals (which if you don’t, you absolutely need to start), you will be presented with a cluster on the right that shows us the order book of the source exchange being used. In this case, it’s Binance Futures.
You can see that the right side of the screen has a continuous volume profile and to the immediate left of that, there are multicolored squares. These squares represent the orders being placed/canceled/replaced in real-time. If you watch carefully, you will see the brightly colored squares move around quite a bit. Cignals data team had a great heads up last week by issuing this tweet, which underscores the point I am trying to make vis-a-vis order books being a breeding ground for psychological assault by whales and API traders.
The tweet states that the order book has been flashing large inventory on the ask around the bull/bear line ($40–2k). The orders were being canceled and replaced at high speed, indicating large size API traders were manipulating the order book. This is otherwise known as “spoofing”, and is precisely why paying attention to just the order book alone is not advised when trading using order flow analysis. It’s important to keep track of the cancel/replace frequency and how many orders get pulled out of the stacks at each level vs getting filled.
This is not to say there aren’t large orders resting at certain levels (icebergs), but when the book starts getting spammed with a bunch of junk quotes, wild bid/ask spreads, and “iceberg” orders hang at inflection zones (like the aforementioned $40–2k b/b line), we have to take into account what is really happening. Remember, the order book is only showing you where size is being placed, it’s not showing you the actual trades. That’s when paying attention to the order flow and price action is very important.
Is there size printing on each level? Are there any buy/sell imbalances printing? Is there any absorption or is the move proceeding unchecked? Divergences? What about the profile? Where is the price in relation to POC/VAL/VAH? Any naked POC’s left behind? Auction process messy and leaving UFA (unfinished auctions) on the chart? If it sounds like a lot to take in, fear not. Ranking these hypos isn’t a daunting task, it’s a lot simpler than you’d think.
Educating yourself on viewing the markets in terms of “what’s actually happening now” instead of looking for a sure-fire “confirmation” signal is the “ah-ha” moment most people are seeking. In reality, once you find the “confirmation” (whatever that may be to you) the trade is already in motion. Using this method of ranking hypos by probability, we are able to better decipher between noise and legitimate entries/exits on our trades.
Trading isn’t an exact science, it’s a very nuanced business. As you get more screen time under your belt, you will begin to calmly digest market conditions and rank the likely outcomes of various setups with ease. What I am trying to do here is illustrate that there is no such thing as a sure-fire confirmed long or short position. We need to take all the clues that the market is giving us in order to get a feel for;
a) what our hypos are and b) how we plan to rank said hypos in the likelihood of occurrence.
As you can see here from the screenshot above, Bitcoin was approaching the bull/bear line at around $40–2k, was swiftly rejected, and price dropped roughly $2k as a result. If you notice the volume profile off to the far right, there is roughly a 55/45 split between buyers/sellers with the sellers having a slight edge. If you notice the cumulative delta bars under the first two red volume clusters (price bars), they show that there is only mild selling pressure. That mild selling pressure resulted in $2k being shaved off the price of Bitcoin within 120 mins. Why do I bring this up you might be wondering?
If you look back to the tweet from the Cignals data team, they alerted everyone that the order book was being aggressively handled on Binance during this move. It’s very likely that market makers and larger size traders saw the book was relatively thin and started setting a bull trap by lifting the market to the b/b line (to entice complacent traders into trading). Once a fair amount of traders entered into late longs to chase the market, the rug is pulled and they get smashed back down to the lower end of the trading range. You can begin to see the order book rotate icebergs (walls) down from $42k to $40k and $39k as price, on decent delta, tries to stage a recovery. Now let’s start to form an opinion of what is possible here.
We know the bull/bear line is $40–2k and price is being rejected off this level on relatively light volume. The screenshot below shows another timely call by the Cignals data team after this move started. They aptly point out that the price has started pulling away from the point of control on the profile to the downside. Again, using order flow and price action together, we can gather more clues about what’s happening now. Thus leading us to the confirmation that we are seeking for our primary hypo. We don’t need to overcomplicate it, it’s honestly that simple.
With that being said, a savvy trader would see the above set up, and could easily surmise that hypo 1 (or most likely course of events) would be that a move to the naked point of control around $33k provides a support target for the bull trap that was only just previously set. Market makers and/or whales were spamming the book to cause panic, it took relatively little volume to push price a couple of thousand dollars off the b/b line, and the likely result would be a flush to the lower end of the range where there were levels of interest open. This is what the Cignals data team obviously had as their hypo 1 which makes a lot of sense. I am using this setup because it was my hypo 1 as well in this situation, and I discussed it a bit with their team in the days leading up to the Memorial Day Weekend volatility.
Given what we know to be happening, a logical hypo 2 (or the second most likely course of events) could have easily been a move back toward the bull/bear line to invalidate the trap set in the previous 2 bars. This was my hypo 2 given this situation over the weekend. We see that there was a big delta spike after the initial move down from ~$41k to ~$38k, with hopes that bulls could push price beyond the $42k barrier & extend the move back to the $45–7k resistance area and beyond. That would theoretically open the door to $60k+ again, and reignite the bull market in a similar fashion to the 2013 run when prices dropped sharply and then rebounded to new highs before year’s end.
As we all know, the market did in fact rotate down towards the $34–3k range that Cignals data team pointed out. Our hypo 1 would have been correct and was “confirmed” by the price action and order flow as explained in the previous paragraphs. That is why Cignals ranked it as their most likely course of events and felt confident enough to send the tweet out. In the event that this hypo wasn’t going to play out, there is a strategy called cut and reverse, which immediately flips the position in the other direction. This allows us to cut our failed trade instantly (or as soon as we realize hypo 1 is busted), and capitalize on our hypo 2 as outlined in the previous paragraph. I will do a separate article on cut/reverse trading most likely.
At the end of the day, all of these crazy moves may seem totally random, or not make much sense at all. It all boils down to affecting collective psychology, as I was stating at the beginning of this article. In our original example from this previous weekend, rapid quotation spreads all over the place, and overall erratic order flow before this major move served multiple purposes. It usually catches algos off guard and when they sniff out the wild behavior on the book, they too join in and create an even more erratic trading environment.
Once you have everyone off guard and panicked to some degree, the rest is human nature. Now that all the larger-size traders, market makers, and other algos have started moving orders around the book, the most levered and the weakest hands will likely be run over quickly, kicking off and adding to the momentum of the move. Spreads eventually start to stabilize, and the next wave of weak hands will exit at the more “normalized” prices.
Iceberg orders appear now, which are large-size orders resting on the book, commonly referred to as “buy/sell walls” by most novice traders. This organically shakes some orders off the bid usually and makes it easier to keep the move going. Stops get run, more traders pile on the direction of the move, and you can figure the rest out.
This is usually followed by what we call rinse and repeat action. Cignals actually highlighted in the tweet about the move down to support around $33–4k, that there was imbalance and business likely to be revisited in the upper end of the range. They further this point by saying, after sorting through the business in the lower half of the range, it would be highly likely that we revisit the top end of the range to sort through imbalances. As of today (6/2/21) that hypo has played out and goes to showcase how powerful of a tool Cignals actually is if used correctly.
All of these seemingly random moves are done to affect the way we think and react to what is going on around us. The forces that move major liquidity at the exchange level have an incentive to get you to fill their orders. It also helps them quite a bit if they can bait you into a bad trade, and you lose money in the process. This is a zero-sum game at the end of the day. There is always going to be a winner and a loser. If said forces can keep you in a state of constant confusion and disarray, you will over-trade yourself into oblivion.
