In comparison to other securities, futures products are notorious for wild, periodic swings in pricing. The reputation is well earned, as history has shown us many examples of the herd mentality leading to chaotic, panic-driven buying and selling. Irrational price action has plagued live futures trading markets of everything from livestock to crude oil at one time or another.
So, what is the underlying reason for sudden market turbulence? Is it the result of a diabolical scheme or a hole in the efficient market theory? The answer is much simpler: It is a phenomenon known as “order flow.”
Depending upon whom you talk to, the exact definition of order flow is likely to vary. Order flow is the mechanism that facilitates a price movement in an open auction market. It is the matching of competitive bids from buyers and competitive offers from sellers, with any incongruity creating a directional move in price itself.
In more basic terms, order flow is simply a movement of price resulting from orders being filled at market. As buyers are matched with sellers and vice-versa, price actively seeks a state of equilibrium. In the event that there are more buyers than sellers, price goes up, and if there are more sellers than buyers, price moves down.
Essentially, order flow is what moves a market!
Orders executed at market, known as traded volumes, act as the catalyst for price action. Traded volumes may spike due to a bulk of market orders hitting the exchange rapidly or through large numbers of resting limit orders being triggered. As a result, both traded volumes and subsequent order flow increase, serving to enhance pricing volatility.
Order flow is bolstered by heightened activity between buyers and sellers, also known as participation. As participation levels rise, the probability of price moving one way or the other as a result of increasing order flow grows.
So, what are the drivers of order flow on standardized futures exchanges? Here are a few factors that may foster robust levels of participation, traded volumes, and subsequently order flow:
Although many short-term traders view these periods as moments of opportunity, a comprehensive strategy must be in place before navigating the turbulent waters of a “hot” market.
No matter what market or product is being traded, accounting for the impact of a spike in order flow is an integral part of prudent risk management. Actively engaging in live futures trading during peak times, a scheduled economic data release, or amid breaking news can dramatically increase exposure to pricing volatility.
The futures markets offer traders a diverse array of products and opportunities. Each venue is unique, with many challenges and pitfalls ready to undermine profitability. Obtaining an adequate knowledge base regarding the fundamental drivers of volatility and order flow requires dedication and resources.
The services of an experienced market professional may help shed some light on the many nuances involved with live futures trading. For ideas on how to incorporate the concepts of order flow into your trading strategy, contact a StoneX broker today.