What Does Oanda’s Order Book Teach Us About The Way Retail Traders Trade ?

Oanda’s order book has many uses. It can be used to find supply and demand levels and it can also be used for trading stop hunts.

Something which alot of people miss is what you can learn about the way retail traders trade from observing the order book. The order book shows us the changes in the open orders and open positions of the traders using Oanda as their broker, by watching how the orders and positions change over time you can get a sense for how retail traders as a whole trade.

This can be useful not only for constructing new trading strategies, but also having a deeper understanding as to how the forex market works. Today I’m going to share some of the insights I’ve gained over the years studying Oanda’s order-book.

 

The Majority Of Retail Traders Don’t Use Stops

Its true……

I used to believe most traders were smart enough to put a stop on their trades, I mean, it only takes one look at some of the forex trading forums online to see that a large majority of the traders active in the market are pretty smart, to think such a large percentage of people can’t even employ the most basic of risk management concepts is quite shocking.

However it only takes one look at Oanda’s open positions graph to reveal that masses and masses of traders keep losing trades open for a significant length of time, if their holding onto losing trades they must have neglected to put a stop-loss on their trade.

image of oanda open postions graph

Take a look at the top right hand corner of the open positions graph.

The two black dots represent a percentage of traders who are still holding onto long positions between the 1.1300 – 1.13500 levels. These traders have been holding onto a losing trade for 22 days ! In that time the market has made 500 pip down-swing against their position which is the equivalent of having a trade open at a £500 loss if your were trading using  the lowest leverage available.

image of traders holding onto losing trades on eur/usd

Here’s where they are on a chart.

Notice how these traders are contained on the wick of a bullish candle, its apparent these traders believed the market was about to climb significantly higher when they placed their buy trades, when the market fell they got trapped into believing their analysis of the market direction was correct and the market was still going to move higher.

I think they continued believing the market was still going to advance higher for quite some time but it eventually got to the point where the market had moved so far against their trades that they realized they were wrong on where they believed the market was going to go but were too scared to close their trade due to the amount of money they would lose.

When the market returns to the area where these trader have been trapped in losing trades expect them to close their position at the first sign of any movement lower.

For them, another move lower is the last thing they want to see happen.

After being in a losing trade for so long all they want to do is close their trades and move on, they wont do this if the market makes a large move higher past the point where they entered their long trades as their loss would turn into a profit and they will be overjoyed that they have manged to make some money after surviving the horror of being trapped in a losing trade for 22 days.

But if the market approaches the area where they have been trapped and begins to show even the slightest sign of a possible move down they will instantly close their trades, they will not be able to face up to the possibility the market may move against them yet again.

You can use these trapped traders to find supply and demand zones to trade.

My article “Finding True Supply And Demand Zones Using Oanda’s Order Book” will give you a full breakdown of how to determine where these zone are located and how to trade the zones when the market returns.

 

Round Numbers Are Important

 

Another thing which I discovered were orders have a tendency to cluster at round numbers. This isn’t a new concept, if you read the two research papers found at the bottom of the cool stuff page, you’ll see the researchers noticed the same thing occurring in the stock markets.

Most of the buy and sell order on the open orders graph are placed at round number levels.

The reason such a large amount of orders get placed at round numbers is due to humans naturally wanting to bring structure to the market, it’s easier for the trader to place a trade at a .0000 number rather than .121343, it makes things easier for the trader to remember and makes the market environment more structured.

Unfortunately due to the fact such a large number of traders place their stop losses at round number levels it makes them prone to having their stops hunted by the market makers who may need to fill large orders for the banks and hedge funds.

You can actually find where stop hunts are likely to occur without using Oanda’s order-book.

image of stop hunt on 1 hour chart of aud/usd

Take a look at the reversal I’ve marked above.

This is a good example of a stop run you probably wouldn’t have been able to find using Oanda’s open orders graph.

When the market drops (marked with an arrow) traders on lower time-frames go short. They see this as a reversal and on the lower time-frames the two bearish candles which form the drop lower make it look like a significant move down has taken place.

The traders who are selling because they think the market is reversing will place their stops at the swing high of the move down, as this is what all trading books and methods advocate. So if we know people have a tendency to place their stops at round numbers then the 0.70400 level just above the swing high is the most likely place these traders stop losses will be found.

The market makers know this too, they know if they can push the market into these stops it will give them the opportunity to offload more sell orders into the market on behalf of the banks, which is what eventually transpires as the market begins a large move lower after the 0.70400 level is hit.

It doesn’t take long to learn how to spot these types of stop hunts taking place, so long as you have a small understanding of how retail traders make trading related decisions ( in this case where they place their stop) and know a little about how and why stops are hunted in the first place it’s quite easy to identify and trade these events when they occur.

 

Retail Traders Are Impulsive

 

There are a couple of articles on this site in which I talk about reactive traders who place trades as soon as they see the market make a large one directional move.

Knowing how reactive traders make decisions is paramount in understanding why many of the things which take place in the market happen the way they do. How I was able to figure out the majority of retail traders are reactive/impulsive was by observing the changes on the open positions graph when large movement occur.

 

image of oanda order book eur/usd

Take a look at the open positions graph above, see how there are a relatively similar amount of people who have long and short trades open ?

The picture of the graph above was taken one hour before the ECB press conference, lets take a look at what happens when the conference begins…..

Aviary Photo_131021000488959530

………Everyone goes short

Look at the high concentration of people who are now short in the market. The bottom spike colored orange is all the traders who have sold because of the large down move, they haven’t gone short because their trading strategy told them to, they have gone short because the large bearish candle makes them believe the market is about to drop considerably.

While this example is taken from a pretty exceptional circumstance ( it’s not everyday you see moves like this ) the concept remains the same. When a large move takes place masses of traders will place trades in the direction of the move, the majority of these traders will have placed their trades at the bottom quarter of the candlestick you see the move on, they will refrain from placing their trade until they see that the market has moved enough for them to believe that its definitely going to fall significantly lower.

image of large downmove on chart of eur/usd

If you look at the open positions graph you’ll see most traders went short around the 1.08300 – 1.08700 levels, I’ve marked this area on the chart above.

It’s clear to see from the image most traders went short AFTER they saw the market make a large move down, this comes back to what I was saying before about how traders will only jump into a large move when they believe the market is certain to continue in the same direction, this means they must see a big rise or fall before placing their trade.

Another thing to pick up on is how the price action changes when the retail traders begin entering the market.

Whereas the move down consisted of one large range bearish candlestick the candlesticks seen immediately after it were very small in comparison, the reason they’re so small is due to the retail traders going short.

You will tend to see this whenever the market makes a large move up or down, at the beginning of the move there will be large range candlesticks, then as retail traders begin to go short the candles will become much smaller, this is the point where the institution who caused the move in the first place begin to take profits off their positions.

 

Traders Move Their Stops

 

In my time studying the open orders graph I noticed how sometimes the stops losses of the retail traders kept changing position slightly ?

One hour they would be at one price, then the next hour the market would have moved a little and the stops would have been moved to another price.

This wouldn’t have been so strange if were not for the fact that such a large percentage of stops got moved, it wasn’t just a few of the stops which has been relocated it was whole blocks of orders.

Aviary Photo_130905369420517984

Take a look at the open orders graph above.

I want you to focus on the buy stops in the top right hand corner of the open orders graph.

Notice how there are two points where there is a high concentration of buy stops, one at the 1.1100 level and the other around 1.1170 level, lets take a look at what happens when the market drops.

Aviary Photo_130905369845772867

The stops at the 1.1100 level have declined and the stops at the 1.1170 level have increased.

Before the drop the buy stops at the 1.1100 level constituted to not even 1% of the total traders using Oanda, now they are at 1.5% thats an increase of more than 0.5% !

You can see this happening all the time, it’s not just on large move where you see traders move their stops you also see when the market is moving slowly, I guess one of the reasons behind why this happens is the traders belief the market is going to move in the direction they anticipated.

If the trader has placed a sell trade and he really believes the market is going to fall then if the market begins moving up he will move his stop to another positions as he is certain his analysis is correct and the market is going to drop significantly.

Seeing this occur with one trader doesn’t really tell us anything, but seeing it happen with thousands of traders means alot of people believe the market is going to go down, when a large number of people believe something is going to happen it usually means the opposite is going to take place.

 

Summary

 

Studying how other traders trade is the key to making money from the forex markets.

With Oanda’s order book we have access to a source of data which is based on fact, the graph doesn’t lie. If the market makes a quick move down and we see that a large percentage of trader have gone short, then you know for a fact they have actually gone short.

On top of this you also know the vast majority of retail traders who aren’t using Oanda have also gone short too.

Collectively traders trade in the same way, if all the traders on Oanda do something then you can bet the vast majority of retail traders have also done the same thing. What we see on Oanda’s order book is basically a proxy for what retail traders as a whole are doing, this is what makes it such a powerful learning tool !

 

 

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