The mystique behind legendary traders like George Soros and Jesse Livermore capturing colossal wealth from market speculation has baffled observers for decades. What closely guarded secrets empower them to consistently beat the markets where so many others fail?
While insider information or immense capital provide key advantages, studying their underlying trading approach reveals repeatable strategic principles applicable for individual retail traders too. The concept of order flow analysis is one such model embraced by the "smart money" to capitalize on the herd behavior of less-sophisticated or under-resourced participants.
This article explains how retail traders can profit from the fragments left behind by smart money trades using the order flow strategy.
Who is the Smart Money?
In financial markets, the term "smart money" commonly refers to:
- Institutional investors – pension funds, hedge funds, proprietary trading firms wielding expert analysis with huge data and technology resources
- Investment banks – with privileged access to material non-public information
- Central banks – with internal visibility into monetary policy decision drivers
These large players obtain a substantial "informational edge" over retail traders concerning likely future price trends. Their trading volumes also allow moving markets in the desired direction through sheer order flow power.
As former hedge fund manager Barton Biggs notes:
"The smart money has better information and better access to information."
For individual traders with limited capital, identification and analysis of this smart money activity offers a viable path to trading success.
From discrete transactions to large orders, every executed trade leaves behind market scars – footprints embedded within price charts as historical markers. Through diligent study, we can uncover the stories behind these scars, understand why the smart money acted when they did and position ourselves to profit from future flow imbalances they create.
Let us now examine more closely how…
Order Flow Analysis Using Market Generated Information
"If you want to understand the market, understand the core underlying participants and their motivations." – Paul Tudor Jones
In any financial market, the buyer wants a higher price while the seller wants a lower one. The equilibrium price level where trades execute represents a momentary consensus between these opposing forces of supply and demand.
However, imbalances routinely emerge between buying and selling pressures. More demand than supply causes prices to rise. Excess selling over buying pushes prices lower. We can deduce who holds the power at various points by studying these order flow ebbs and flows playing out as price action patterns on charts.
Order flow analysis techniques examine market generated information, including:
- Trade volume profiles
- Price action patterns
- Market structure levels
- Sentiment and participants positioning
Instead of predictions, probabilities or complex indicators, traders utilize actual executed trades and observable prints on the tape to construct market hypotheses.
Under this approach, past order flow outcomes have a higher chance of repeating if similar conditions reemerge. Core assumption – history tends to rhyme!
Now let‘s explore specific concepts within order flow analysis to profit from positions taken by the smart money…
Trading Order Blocks to Capture Momentum Surges
Among the array of order flow techniques, the order block strategy provides a structured approach combining multiple key elements:
- Understanding prior high volume areas indicating strong interest
- Recognizing probable turning points
- Positioning early into a new directional move
- Riding price momentum for maximum run
But what exactly are order blocks?
Order Block Definition
Order blocks represent tight areas on the price chart where significant buying or selling interest has been recently transacted at a key support or resistance level.
These high volume zones often arise around potential market turning points and offer valuable clues regarding dominant participants and likely future direction.
In a sense, order blocks symbolize market scars – remnants of intense battles between opposing forces. Their main attributes include:
- High trade volume – unusually large market orders rapidly executed
- Price rejection / test – failure to break higher or lower
- Swift reversals – sharp directional flip or rotation
- Often leave wicks (long upper/lower shadows)
- Formed during breakdowns, breakouts, tests of support/resistance
Reasons Behind Order Block Creation
Why do such high volume clusters generating swift price rejections occur?
- Large institutional orders absorbed at key levels
- Fundamental news events sparking heightened volatility
- Release of crucial economic data surprising markets
During order block development, we see speculators and participants with shorter time horizons getting trapped on the wrong side forcing them to cover positions urgently.
Meanwhile, smart money utilizes these short-term liquidity crunches to accumulate favorable longer horizon positions. Dumps get absorbed rapidly by stronger hands.
Thus, order blocks demonstrate areas where strong buyer / seller conviction overwhelmed the opposite side temporarily.
Strategic Value of Order Block Analysis
For traders, order block zones make salient price levels to incorporate into analysis:
- Indicate strong commitment by one side – reflects genuine supply/demand
- Highlight potential exhaustion of prior move – momentum slowing
- Help assume trend bias based on order block type – bullish or bearish
- Present probable reversal points to target entries
In summary, order blocks capture where smart money asserted itself momentarily to wrest control from the herd. By anticipating pullbacks and continuations, we strategically board their ship early!
Now let‘s examine some trade examples…
- Bullish order block forms after prolonged downtrend (A)
- Price makes higher low – potential trend reversal signal
- Retest of order block – long trigger with stop under recent swing low
The subsequent strong impulsive move allows securing over 4R profit!
Next example…
- Bearish resistance block (A) seen after extended uptrend
- Gradual retests of the high volume zone
- Potential short trade on decisive breakdown below order block
Here the trapped longs from previous move are forced to close positions fueling continuation.
These real examples demonstrate how combining order blocks with classic change of behavior concepts can produce winning trades!
Optimizing Order Block Strategy for Maximum Accuracy
While order blocks represent HIGH PROBABILITY trading zones, some tips to optimize potential entries include:
1. Focus on Fresh Zones
The more recent the order block, the greater relavance for current participants. Avoid trading older zones from past price history.
2. Filter Setups Using Indicators
Combine order blocks with other confluence – trendlines, moving average crosses, momentum oscillators.
3 Use Right Timeframes
Higher time frames – daily, weekly charts produce more reliable order blocks. Lower timeframes help fine tune entry triggers.
4. Measure Previous Moves
Estimate next impulsive move by measuring previous trends. Useful for setting profit targets.
5. Trail Stops on Winners
Have stop loss discipline, but also actively protect profits as trade moves favorably.
Through additional analysis and risk control, traders optimize strategy edge.
Managing Risk When Trading Order Blocks
Alongside seeking many winning trades, managing losing trades is equally vital. Avoiding significant drawdowns allows surviving to play another day and lets profits compound.
Use reasonable stop loss sizes – Initial stops wider, then taper down bringing closer once in profit
Cut losses quickly, Let winners run – Losses small and fast, profits slower and larger
Consider partial profit taking – Especially on outsized volatile moves meeting targets quick.
Avoid overtrading – Patience after wins/losses avoids revenge mindset
Trade small positions – Lower risk lets focus on executing process over money.
With robust risk protocols, results become less dependent on factors outside individual control.
The Psychological Game of Order Block Trading
Legendary traders like Stan Druckenmiller consider emotional discipline even more vital than analysis prowess:
“The key is not predicting markets right, but rather handling markets wrong”
Alas, backtest engines and market theorems cannot account for very human compulsions.
Real world performance suffers due to:
- Overtrading and revenge trading after losses
- Prematurely exiting winning positions
- Chasing random moves contra plan
- Hesitation and procrastination on entries
Establishing entry/exit rules is easier than adhering to them!
Here are some psychology tips:
- Celebrate but review both losses and wins dispassionately
- Measure progress across series of trades, not single outcomes
- If on tilt – stop trading. Restrict size if uncomfortable
- Follow plan without hesitation when criteria met
Through self-awareness, self-correction and risk-controls, the trading journey becomes smoother, more systematic and consistent.
Conclusion – Trading Against Emotions, With Market Facts
In The Art of War, eminent strategist Sun Tzu declares:
“If you know the enemy and know yourself, you need not fear the result of a hundred battles”
Through order flow analysis, retail traders better understand the investment drivers and sentiment shifts behind smart money whale trades. By strategically positioning early with institutional order flows, individual participants give themselves the highest probability path to consistent profitability.
The concepts shared here – order blocks, change of character, managing risk and self-discipline are by no means exhaustive. But they set the foundation to keep learning the realities of financial markets.
Legendary traders earn their stripes through tremendous pain, persistence and personal risk before harnessing their edge. Yet armed with the right frameworks, newcomers can now fast track the learning curve to trade against emotions but with powerful facts!