Liquidity & Order Flow and How it Affects our Orders

Market makers need to be very aware of liquidity and the level of liquidity will have
significant implications for their trading. In this way they are, yet again, far deeper
thinkers than chart traders whose analysis methods make no provision for liquidity.
This is an area that very few retail traders think about, so it may take some time for
you to incorporate it properly. I find that many clients struggle with this skill initially
but to master the market maker style you will need to work this out. It will likely take
time to fully learn and implement this – again, don’t rush.
(Note, it is hard in this format to fully explain some concepts as I would in one on
one sessions and this is one such topic. I would expect though that those with decent
experience of futures trading understand what I mean by fast and slow markets as
well as concepts such as thick and thin markets)
This chapter follows on from and adds to the previous chapter on queue position so
make sure you fully understand that topic before moving on to this.
The first and perhaps easiest stage of this process is to look at how many contracts on
average there are on each bid and offer. Remember, too, that this can change intra day
and certainly day to day, so this is another area we must constantly reevaluate.
Next we need to look at the current order flow. Our style means that we want to be in
and out of trades very quickly. Exactly how quickly is possible will depend on the
contract. Different markets operate at different speeds, for example the ES in Asian
time is much slower (trade by trade) than the ES is in US time. Here there is some
experience required, that is why this skill is something that will take time to master.
If we believe that for example, that 5 seconds is more than enough time to get a
quick fill, then what we need to do is to work out on average, how many lots trade in
our market in 5 seconds. Let’s say the answer to that is, 190 contracts trade on
average every 5 seconds. This means that in order to get a quick fill, we need to be no
worse than 190 in the queue. So if you want to go long but see there are already 400
on the bid, you can’t trade here. This is how we dovetail this liquidity analysis with
queue position.
Similarly, as discussed in the last chapter, if we want to buy and there are in this
example, 150 on the bid then that would be fine for us to join however, if we are
trading a slow moving market (looking for 1 tick) and the offer had 450 on it already,
then we could not join the bid for the entry trade because the exit is blocked by too
much volume.Analyzing liquidity and incorporating that with queue position and order placement is
an essential skill of good scalpers. It is something which you may find hard to begin
with but you should look to improve on this area over time.
If trades are going wrong, one question you will need to ask is ‘was my fill too
slow?’. In a slower moving market, a slow fill is a sign that your queue position was
too far away. However, it may take time to understand what is a slow fill. When I
trade a new market I know it will take a number of trades before I can get a good
grasp of how long is too long. I can then adjust my queue position accordingly having
adjusted the time-frame I am analyzing liquidity for.
What I mean here is that, if I suspect the fill is too slow and I was previously wanting
to get filled in the first 10 seconds, I can adjust that to say, 5 seconds and then
reassess the average volume over 5 seconds and adjust queue position accordingly.
Particularly if other areas of the trade looked OK then your queue position/length of
fill could be the problem.
As we will see over the coming pages, there can be many reasons behind a bad trade.
While most retail traders tend to only adjust the entry or exit prices, there are actually
a number of other things we can adjust. Queue position and length of time we leave
our orders are among the others.
A reminder that if you expect to be filled within 5 seconds with the normal order
flow, and after 5 seconds you are not filled, then you should cancel the order. You can
then wait a few seconds and if you still like the trade and the queue positions are still
good then you can always reenter. I realize that the new queue position will be worse
than the previous one but as long as it is within your parameters it is still fine to trade.
If, during the next 5 seconds we do get the ‘normal’ volume then you can now get
filled. Doing this achieves two things. First we acknowledge that sometimes for a
brief time, liquidity drops so we cancel our order accordingly. Second, by pulling our
order after a few seconds we reduce the risk of being picked off by a large trade. I
would rather enter, pull and reenter a trade then just leave it in there for a long time.
By doing the later, you are becoming a resting limit order – or sitting duck!
You will find that this topic is one which may take more time to master. Certainly
experience and specialization help. One of my clients wrote to me how after several
months of trading his market (NQ) he not only had a much better understanding of
the liquidity aspects of his market but also the pace of the market. He watches how
many trades per minute in his market and knows that below a certain amount, itbecomes harder to trade so he stays out. Pace of market is linked to liquidity and two-
way flow too. For market makers, these are all important issues.

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