The game of trading is really a mindset where you analyze the price movement based on what other market participants are doing and are thinking. The main goal is to understand how the other market participants make their trading decisions and how they execute their trades. Focus on analyzing the market context because this is the most crucial thing if you want to step up your trading game plan.
Statistics have shown time and time again that the majority of traders lose money so if you can learn how this particular group of traders think and trade you can develop an exploitable trading edge.
Why is the Game of Trading Important?
Why it’s important for being a successful trader to view the market through the lens of other market participants? If you can’t think objectively of the market forces (supply/demand forces) that drive prices up and down you’ll never understand how the market really works. And if you can’t grasp how the markets work, how could you even trade something you don’t understand?
The game of trading goes beyond the price action; it’s an effort to understand the other market players. We have learned that buy and sell orders or the supply and demand are what moves price and since orders are executed by traders it’s important to view the market in terms of what other market participants are thinking and in terms of their worst fears and greed.
Let’s put the order flow mindset to the test.
When you buy any security, in order to make a profit you need other market participants to buy after your entry point. If there are enough aggressive buyers to consume the supply side the price will move up. The conclusion is that you need other traders to form a bullish bias and more they need to go long for the market to move in your direction.
Inversely, the same is true, when you sell any security, in order to make a profit you need other market participants to sell after your entry point. If there are enough aggressive sellers to consume the demand side the price will move down. The conclusion is that you need other traders to form a bearish bias and more they need to go short for the market to move in your direction.
The Order Flow Mindset at Work
To trade effectively your analysis should focus on what other market players are thinking. You need to know why and how the other market participants based their trade decisions on. Identify price areas on a chart where the other market players are most likely to buy and sell and a new horizon of trading opportunities will emerge.
In other words, you simply need to do the following things:
- Identify price zones where other market participants, especially retail traders, will buy after you.
- Identify price zones where other market participants, especially retail traders, will sell after you.
- Identify price zones where other traders will place their stop loss.
The price is a representation of human behavior; therefore it’s based on the sentiment of the majority of market participants. Because it’s based on human psychology and emotions like fear and greed the price is not a true representation of the fair value.
The way the game of trading works with an order flow mindset is related to the human behavior.
What do we mean by this?
Well, as a general untold truth, all markets will continue to move in the direction where it can cause the maximum amount of pain to the majority of the traders.
So, in what situation traders feel the greatest amount of pain?
- First, when their trades are in negative and they suffer a draw down. At some point they are going to reach a maximum pain threshold when they will need to accept they are wrong and liquidate their position.
- Secondly, when their trades are in profits, but the market moves against them. At some point they are going to reach a maximum pain threshold when they are forced to accept their trade is no longer valid and liquidate their position before they lose more from their position.
Knowing this valuable information, you can now act upon this pain factor and aim to target those prices that will cause the maximum amount of pain. When the maximum amount of pain is reached, this will release order flow or in other words, liquidity that many big players seek to target.
Let’s take a look at a practical example.
The figure below is an example of how you should judge the price action from an order flow perspective. Short term the price is moving in a downtrend and forms and intraday support. This down move for sure will attract some seller. At point A, price breaks below support which will trigger another wave of selling pressure as breakout traders enter the market.
GBP/USD 1-H Chart
Down the road, indicators based traders will also get their short signal entry (point B) usually after the breakout due to the lagging nature of technical indicators. The later all these market players enter the market, the less profit margin they will have.
Price is heading into support at point C which most likely will attract bullish order flow and within the context of long-term bullish trend – not seen here current market supply can be consumed easily by the big buyers.
At this point, we can’t know for sure if the market is going to continue down or the demand side will overwhelm the supply side and the price will reverse. So, we let the price unfold and once the market turns we can now understand how these sellers will react once their maximum pain threshold will be reached.
In the above figure, we can see the outcome as the buyers stepped into the market, we assert that as the price progresses upwards these sellers will start to feel the pain of the market going against them and once in a drawdown they will be forced to liquidate their position using buy order which will further reinforce the demand side and help the market push higher.
The real game of trading is to view the market through the lens of other market participants and their trading decision will help you understand the market at a more comprehensive level. With an order flow mindset from now one, you’ll base your own trading decision on other market participants’ decisions and how they trade. Sometimes those traders are triggered because of some technical or fundamental factors.
To put it simply, trading in this new reality of the market is to trade based on what other traders and more precise losing traders make their trading decision and how they trade the market. The game of trading is all about creating and narrating a story behind the price action and the more you practice the better you’ll become an astute trader.
Thank you for reading!