The Order Flow Trading label has been applied to many things. From tape reading… to microstructure analysis… to option and stop hunting… to technical pattern rationalization -- it seems that any time a trader makes a decision based on order mechanics they call it order flow trading. While one could justifiably consider any of these to be “order flow trading,” the reality is that it’s all of them and more.

At its core, Order Flow Trading is a mindset. And not just any mindset! It’s a mindset that exists one level higher in abstraction than the one most other traders in the market think on.

OK… and uh, what in Sam Hill does that mean exactly?

Well, what I’m talking about here is something called the metagame.

In short, the metagame is the “game within a game” where players make decisions, not on the basis of an elementary strategy called for by a game’s rules, but on information that exists outside the game.

For example, in the game of chess there is a strategy of play that makes it possible to win a match in just four moves. If Player A watches Player B employ this four-move strategy five times in a row, then acts to thwart that four-move strategy before it becomes evident that Player B is employing it, Player A is “playing the metagame.”

In that example, Player A is not making his decisions based solely on the inherent value of his strategy. What he is really doing is exploiting his knowledge of the other player to gain a strategic advantage. And that’s precisely what the Order Flow Trading discipline attempts to do within the game of financial market speculation.

Of course, the way order flow traders do it is a great deal more complex because the speculation game is so much more complicated. Where chess has two players, a finite game board, and a discrete beginning and end to each game, financial markets have thousands of players, an infinite range of prices, and the game is played across an open-ended time line.

However, even with all these dissimilar aspects, the thought process both metagame strategies employ requires the same three steps:

Step 1 - Learn the Rule Set

Metagaming is all about anticipating the choices of one’s opponents. However, before one can realistically anticipate those choices, they need to understand the scope of the choices available. That means understanding the rules.

In a game like chess, the rules are contained in a readily accessible rulebook. That rulebook defines how each game piece can move, the structure of the game board, and the timeframe within which each player is permitted to act.

The financial market corollary to this rulebook is the field of Market Microstructure. Even for a game as complex as financial market speculation, the rules impose clearly defined restrictions on the strategic choices available to each player. Microstructure explores those rules and the restrictions they create. Therefore, before you can play the financial speculation metagame, you need a thorough understanding of the market microstructure.

Step 2 - Study your opponents and determine the strategies they are likely to employ

Learning the rules is an important step. But, it isn’t enough to just know what is and isn’t possible. You also have to develop an intimate understanding of the way people play the game.

At first, this might seem like a daunting task. After all, complex games like chess and financial market speculation have a near infinite variety of ways in which they can be played. However, after careful analysis it quickly becomes apparent that even though it CAN be played in an infinite variety of ways, most players tend to consistently employ a number of “elementary strategies.” Once you know those strategies, figuring out which one your opponent is likely to use becomes much easier.

An elementary strategy is one that is well understood, accepted as viable, and consistently used by serious players of the game.

The game of chess has 50 or so of these elementary strategies, including things like the Benko Gambit opening, Pins and Skewers midgame, and the King/Rook endgame. If you know all these strategies, you can not only play a damn good game of chess, you can easily identify which strategies your opponent is using.

In the realm of financial markets, these elementary strategies come in the form of common technical and fundamental trading systems you read about in most trading books and forums. Moving average crosses, support resistance breakouts, and Fibonacci retracement strategies are a few examples of the elementary strategies of the speculation game.

Once you have familiarized yourself with these strategies, it becomes possible to anticipate how the players who prefer these strategies will act. And that gives you many strategic advantages when playing against them.

Step 3 - Adapt your own strategy to exploit the weaknesses in your opponent’s strategy

Once you know the rules, and the strategy your opponent(s) are using, the final step in the process is to exploit that information by tailoring your own strategy to take advantage of the weaknesses in theirs.

If I had to give you a definition for Order Flow Trading, that would be it.

Of course having a definition for the methodology will only get you so far. Actually figuring out how to do it in the real world is where the profits come from. The good news is, it's fairly easy to:

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