High Probability Trades Using Supply & Demand Order Flows

Professional forex traders who make the most money all use order flow analysis as part of this system. When understood properly, order flows can accurately identify imbalances in supply and demand and can then be used to predict future price directions with win rates approaching 90%. In this video I'm going to explain the supply and demand order flows between customers and market makers which can help you make high probability trade decisions. Regardless of fundamentals, sentiment, prevailing trends or anything else, prices move as a result of the interaction between customers and market makers. When customer demand exceeds the supply of liquidity provided by the market makers, the price will move. Let's say this is what the depth of market looks like. We have several market makers all competing to attract customers. So we have the best, most competitive prices from the highest bid and the lowest offer that we call at the market. And this is what we see on the price chart. But then behind that that we have all of the other quotes altogether. This is how much liquidity is available and in this example it is equal on both sides. Then we have customer A who wants to buy 1 million and customer B who wants to sell 1 million. So equal customer demand. Trader A's market order takes the liquidity on the offer here. So VAT quote is removed. Trader B does the same thing when their market order takes the liquidity at the bid. As a result of votes quotes being removed from the market, the spread widens. Competitive market makers would submit new bids in office to fill that gap. And that's what happens in a well balanced market and why we see prices going sideways in a narrow range. Now let's have a look at a slightly different situation. We still have equal liquidity on both sides of the market, but trader A is coming in with a $5 million order. Trader B only has a $500,000 order, so there are more buyers than sellers. When trader B submits their market order, it only takes half of the quoted liquidity that is available at this bid. So the price won't move. The quote amount will change from 1 million down to half a million. But the price level stays where it is. The market maker is seeing they still have half a million they're prepared to buy at this price. But when trader A submits their market order, it's bigger than the liquidity on offer. Demand exceeds supply. So it takes 1 million here, then the next million, then the next million and so on until the trader has bought the full 5 million he wanted. As you can see, the price has moved up but not down. The liquidity on the bid side was greater than the demand from the customer. So the customer's order was simply absorbed by the liquidity and the price didn't move. But the liquidity on the offer side was less than a demand from the customer. So the customer's order ate through multiple levels and that can move the price pretty quickly. But now let's look at another scenario. Trader A and Trader B are back with equal size orders. But this time the liquidity on either side of the market is different. There is significantly less on the offer side, so there's an imbalance. Trader B's order does the same thing as before. It's only half the size of the liquidity available at the bid, so it's absorbed and the price doesn't move. Supply exceeds demand in that direction. Trader A's order is again much bigger than the liquidity on the other side, despite the fact that the order itself is the same size as Trader B. So it eats through the limited liquidity on the offer at multiple price levels and the price moves up. Demand once again exceeds supply in that direction. In one scenario, there we have equal amounts of liquidity from market makers but unequal sizes of orders from customers. In the other scenario we had equal sized orders and customers but unequal amounts of liquidity from market makers. And in both cases the price went up. Prices move because of imbalances between customer demand for and market maker supply of liquidity. It is a simple supply and demand equation. You could actually have more sellers than buyers and the price will still go up. As you can see from this example on the screen, there's four times as much selling from customers compared to buyers. But the liquidity is so unbalanced that the price will go up, not down. Prices move because of supply and demand imbalances. And that is why tracking dealing desks and market makers is so profitable for professional traders. Price will move in the direction of least liquidity relative to demand. Valising mathematical certainty of forex market mechanics. There was a scientific paper produced by three researchers at Stanford University a few years ago and they found that just by measuring the liquidity volumes from market makers, they were able to predict the price direction 81% of the time. All they did was compare the amount of liquidity on the bid side to the liquidity on the offer side. If there was an imbalance greater than 10 million 81% of the time, the price moved in the direction of least liquidity. That's incredible when you consider they didn't look at the customer demand activity at all. They only looked at 1/2 of the supply and demand equation. Now, if you've watched my previous videos, you know that market makers profit from the spread. In an ideal world, they don't want the price to move. They want to buy from one customer and turn around and instantly sell for a higher price to another customer and they pocket the difference. If they don't manage to do that fast enough and the price moves against them, they can get caught out. Contrary to popular belief, market makers have trading risks just like us speculators. So let's go back to that example from a moment ago where trader A's order was much bigger than the liquidity on offer and and quickly push the price up several levels. In that situation, market makers sold but didn't manage to buy at below a level before the price moved past it. Which means they are now in a small loss. To cut that loss, they want to buy at the next available best level. And to do that they need to be competitive. So as the offer prices started going up, they raised their bids to fill the gap. And in the meantime they also want to avoid adding to that loss by selling any more. If they had a competitive offer, they might end up selling to another customer. So they move the offer even higher to get out of the way of the market. That of course creates a liquidity imbalance. They progressively reduce the size of their offers whilst also raising them higher. And at the same time they competitively improve their bids. And in a side by side comparison that would look something like this. This is the situation that the Stanford University research has established would result in a further price move in that direction 81% of the time. Remember that price is mathematically more likely to move in the direction of least liquidity. We know that is a fact in financial markets. So we've got a self perpetuating cycle that feeds on itself and gathers more and more momentum. When big market orders initially consume the liquidity quite quickly, it creates a cascade effect as market makers reduce the liquidity to manage their losses, which then exaggerates the liquidity imbalance and speeds up the price move even further. This is the mechanics behind the scenes. When you see a sudden price spike that apparently happens for no reason and no news release. If there are more buying customers than selling customers, the price is more likely to go up. If there is less offer liquidity than bib liquidity, the price is more likely to go up. If you can see when both of those situations coincide, you now have the perfect conditions for the highest probability of predicting the next price direction. And there are institutional tools that show you this data for both the market liquidity and the customer order volumes. And with it you can take your trade into a whole new level. The problem is they're not user friendly for amateur traders because A they require high frequency custom algorithms to make trading decisions due to the speed at which the data changes and B they are extremely expensive, costing around $30,000 a month on a subscription. So unless you have a seven figure trading account, these are not worth it. But there is an alternative and there's actually an even better solution. There are companies out there who pay for this data each month from the institutional providers and then use algorithms to to translate that raw data into usable and very friendly tools and displays. And then through economies of scale, they pass it onto you in the retail sector in the form of low cost cloud based indicators or trading robots. And using these means you get all of the benefits and the advantages of the institutional data. But it's already been decoded and put into a more usable format and it only costs you a few dollars instead of thousands. This is something that most traders are completely unaware of, but it's a game changer if you really want to make a lot of money with less effort. Let me know in the comments if you would like me to do some more videos on the tools that are available to you and I will do a review and go into more depth about how they work and what they can do for you. This video was just a brief introduction to order flow analysis in general to explain how it works and how it can predict price direction more accurately. And I really hope you have found this interesting and helpful. If you have, I'd really appreciate it. If you would like it, leave a comment and subscribe. It will help support the channel and that way I'll keep producing content like this so that you can become a better and more profitable trader. Thank you and I'll see you next time.