Walter Lesicar is a professional order flow trader. The article below asks essential questions pertaining to liquidity and order flow. Walter uses dxFeed Bookmap to answer these questions.
5 “ Why? ” questions every trader should ask himself / Walter Lesicar
In trading we all tend to ask nearly every day:
- Why did price stop?
- Why can’t we predict price?
- Why is this the top or bottom?
- Why does the price break a certain level?
- Why are others placing fake limit orders?
And of course numerous other “Why” questions.
The “why” question is so powerful and omnipotent that it can sometimes torture us. Then we look for answers and solutions by force to find answer to “WHY”.
To cut a long story short: There are rarely satisfactory answers to the “Why” in trading. We can only begin to understand answers to a certain point.
Why isn’t a Classical Chart helpful?
Candle Chart with Trend Lines
What can you say about this chart?
- It is a clear trend up
- The trend line is up
Now you may say: “There is a trend” and “This trend will continue”. But in fact, it only means: “There has been a trend until this moment.” It should be clear, there is no evidence this trend will continue or reverse. At this moment we simply don’t know. We assume and we hope.
Why does this trend stop here? Why did it reverse? Why did it continue?
I believe these questions can’t be answered based on classical charts. Why not? Because we don’t see what is happening and don’t have any indication what is “behind the curtain”. We are the “audience” and we see with an extremely limited view using trading software.
Classical charts based on Technical Analysis (TA) are misleading because they use historical data to plot patterns. Classical technical analysis leads you to assume patterns develop in a defined predictable environment. However, these patterns actually unfold in a truly random and unknowable sequence.
Informed vs. Uninformed Traders
I refer to the informed traders as the investors who have a temporary informational advantage over other market participants day trading stocks. They obtain this informational advantage because they either have some proprietary information or they are able to correctly process new public information more quickly than other investors in the market with day trading software. 
The informed investors typically use their temporary advantage to trade with the uninformed investors and extract profit from these transactions.
The second main assumption is that the informed investors act on their information by submitting buy or sell orders. Thus, the informed investors partially disclose their information through their trades that cause higher permanent price changes, compared to the trades of the uninformed investors. 
When a large number of informed traders enter the market, it signals a higher probability of a price change in the near future after information has been released to the market. However, uninformed traders do not know the direction of the price change since they are unaware if the news released will be positive or negative. 
“Informed” traders possess more information about a company, stock, or event. “Uninformed” traders are risk averse and traders who represent liquidity providers.
Why can’t we predict the price?
As you know, an Order Book consists of a “Limit Part” and a “Market Part”. The limit part (‘passive orders’) represents all Limit Orders which are placed by informed and uninformed traders. The market part (‘aggressive orders’) represents all orders which hit the market by both groups at random times.
Why can’t we predict where the price is going next? Because we can’t foresee when and how aggressive market participants are hitting the order book at the market price level — the arrival of aggressive orders is hardly predictable.
But there is a chance, though!
Why analyzing passive orders?
If the arrival of aggressive orders is hardly predictable, we must make this prediction based on observation of passive orders:
- Are they weakening from the pressure by aggressive orders?
- Do they desert, cancel or move orders away?
- Do they stand the ground and absorb the pressure?
- Do they bring even more forces?
Observing market depth and answering these questions helps to predict the outcome.
Why is the price bouncing off? Because informed traders are bringing more liquidity (or limit passive orders) to the price level.
Informed traders adding liquidity
Why does price falling through specific price levels? Because informed traders are canceling their limit orders.
Why does price hold a level? Because informed traders are standing their ground and absorbing all incoming market orders.
Informed traders are absorbing market order
Why Is Liquidity important?
We can always detect liquidity concentration above and below the current market price.
On dxFeed Bookmap™ liquidity concentration can be seen in advance. If price reaches this level, then price can:
- Price goes through, because passive limit orders retreat, making the liquidity mark at this level irrelevant
- Aggressive orders retreat and fail pushing the price through the liquidity – price bounces back
- Fight between aggressive and passive orders, leading to large traded volume cluster
Liquidity is the “blood” of the market and its observance in daily trading turns an uninformed trader into an informed trader!
See also Liquidity 1 – Liquidity 3 in the Post section of my website.
Why are traders placing fake/spoof orders?
First of all, I wouldn’t speak of such a thing as a “fake” bid or offer. It is a “No Intention” to buy bid or to sell offer orders though. Basically, the reason large traders (and some smaller traders in thin securities) do this is to give the impression that there is either an abnormally large buyer or an abnormally large seller in the market.
Consider the following:
If you are day trading stocks and have a large amount e.g. 100.000 shares, or Future contracts e.g. 1000 contracts to sell, then you can’t do it all at once because you would manipulate the price to your disadvantage.
Likewise, if you display the order to sell on level 2 with day trading software, people may see that there is a (legitimate) large seller in the market and sell, driving the price down and preventing you from selling where you want as well as lowering the value of your investment.
Another option could be to sell 1000 Future contracts but hide it on level 2 as not to scare people. Otherwise, you could place 200 contracts to inform smaller traders there is enough liquidity so they can buy 50, 100 or more contracts if they want, but not so much that there is a need to have 1000 and more buyers behind them to make the price go up.
The problem with all of this is that you want to sell a large amount of contracts/shares into a market that doesn’t have many buyers.
You need demand. To create demand you might display/spoof/fake a buy order with NO INTENTION to buy of, let’s say 500 contracts on the bid. Now it seems that there is a large buyer in this market. This will create demand and entice retail/uninformed traders to buy. They will begin buying from you as your hidden sell order get filled piece by piece.
This is a risky game for the seller, though. As mentioned above there are no such things as “fake orders”. This 500 buy order is real at that moment! If there is a big seller right at that moment when the intentional seller is trying to find buyers for his inventory and if he doesn’t cancel his orders fast enough he will get a fill and will be long 500 contracts more.
That’s the real risk of placing “non-intentional” orders. Besides, it is illegal under the 2010 Dodd-Franck Act.
Everything can be inverted with trading software to spoof on the sell side and create artificial sell pressure if there is a need to buy before the price goes up. Both of these things are, despite being illegal, practiced pretty regularly by manipulative hedge funds and large traders.
HFT’s do this as well but very, very fast so you often won’t catch it on level 2 unless you are working with a level 2 visualization software like Bookmap is. Algos can use it as a method of price discovery also.
dxFeed Bookmap visualizes the market and enables stock traders to answer the WHY’s. It really all about the liquidity. By analyzing the liquidity, they can understand why specific market movements unfold, and this allows them to make more informed trading decisions. If you’d like to learn more, please attend a dxFeed Bookmap webinar.
- Informed Trading and Market Efficiency by Olga Lebedeva, 2012