Attention Traders,

Please refer to the following table for the 2024 Christmas and 2025 New Year Holiday Trading Schedule:

Thank you for your prompt attention to these matters and happy holidays from the team at Optimus Futures!

If you have any questions, please contact us at: (800) 771-6748 or send us an email at: support@optimusfutures.com

Attention Traders,

Optimus Futures would like to wish you and your families a Happy Thanksgiving!

For your early planning, here are the holiday trading hours for the 2024 Thanksgiving holiday between 11/27/24 – 11/29/24:

Please keep in mind that all times listed above are Chicago Time – CST.

Thanks for your prompt attention to these matters! If you have any questions, please contact us at: (800) 771-6748 or by Email at: support@optimusfutures.com.

Attention Traders,

Please refer to the table below for a complete list of trading hours for the upcoming Independence Day (July 4th) Holiday:

Thank you for your prompt attention to these matters! If you have any questions, please contact us at: (800) 771-6748 or send us an email at: support@optimusfutures.com.

This article on Best Order Flow Indicators is the opinion of Optimus Futures.

• What Indicators should you consider when reading Order Flow? 
• How do you identify the big player’s trades? 
• How to add VWAP to your market analysis 

When trading financial assets, it’s crucial to utilize the best order flow indicators available. We often rely on charts to identify market opportunities, which help us detect patterns that might indicate future price movements.

These charts serve as essential ‘maps,’ highlighting potential headwinds, tailwinds, critical levels, and turning points in the market.

On every chart, price and time are typically the dominant features. However, while indicators are variable and supplemental, they play a critical role in successful trading strategies.

Although ‘volume’ is sometimes overlooked and treated merely as another indicator, savvy traders understand that the combination of price, time, and volume, when analyzed through top order flow indicators, can reveal the true driving forces behind market movements—far more significantly than any single factor alone.

Understanding Order Flow Indicators for Market Analysis

Here’s a key concept: Price, time, and volume drive order flow.

Price movements within a given period are often misleading unless you analyze the volume driving them. Understanding the volume of trades is crucial, but it only becomes meaningful when considered in the context of price and time. Indeed, the intertwined relationship of time, price, and volume defines the dynamics of trading.

By integrating these three elements—price, time, and volume—you gain a more comprehensive view of buying and selling pressures. These are the critical factors that drive the order flow behind price movements, offering insights into market direction and momentum.

Now, you might wonder, ‘What are the best tools to detect and interpret buying and selling pressure?’ We will explore the seven best order flow indicators, which are especially valuable for short-term trading scenarios. 

Essential Order Flow Indicators for Spotting Market Trends

Here, we will provide a concise overview of each indicator. If you’re eager to experiment with these indicators yourself, you can easily access them all on the Optimus Flow platform.

1 – Power Trade Scanner: Uncover Market Momentum with Real-Time Data

Imagine a scenario where there are more buyers than sellers for a particular product. Typically, this imbalance means the price of the product will likely increase as buyers outbid each other, and sellers raise their prices to maximize profits.

Conversely, when sellers outnumber buyers, prices tend to decrease. This dynamic is a fundamental concept in understanding market forces.

Such market behavior often generates momentum, a crucial indicator of which direction the market might move next. Whether this momentum suggests an upward or downward price movement, it provides valuable insights for traders.

Detecting whether buyers or sellers dominate the market within a short period can be a clear indicator of this momentum.

However, how can you detect these large transactions quickly and accurately? Most conventional volume analysis tools fall short in this area.

This is precisely why tools like the Power Trade Scanner are invaluable. Designed to detect order flow imbalances swiftly, the Power Trade Scanner can help you capitalize on these quick shifts in market dynamics.

As shown in the image above, the yellow highlighted sections pinpoint large order executions that take place within a very short time span (like 3 seconds, or however you might want to customize it). By allowing you to see these short moments of high-volume trading, you are able to gain insight into probable near-term price directionality.

2 – VWAP Indicator: Align Your Trades with Institutional Activity

Have you ever wanted to trade alongside large financial institutions such as mutual funds, hedge funds, and other large investors?

Well, the VWAP indicator is one tool that can potentially get you on the same side as the bigger players on Wall Street.

VWAP stands for Volume Weighted Average Price. It’s a mouthful, but this indicator shows you the “average price” of a security based on both volume and price.

Now, why is this so important to institutional traders? When large funds need to buy or sell assets, they often do so in huge amounts.

The last thing most of them want to do is move the markets in the process of buying or selling, as that would obscure prices, making it difficult for them to complete their transaction.

To help prevent this from happening, they will often buy when the asset price is below the average price and sell when the asset price is above the average price.

And to determine where asset prices are relative to average prices, many of these funds use the VWAP indicator as a tactical tool to assist them in their transaction.

As a trader, you can also use it to increase the odds that you might end up trading with and not against the larger funds.

As shown in the image above, you can overlay different VWAP levels to get a picture of different average price levels based on time frame.

If you’re using VWAP levels as price targets, you can use support and resistance as entry levels, or you can use any standard deviation-based indicator (as shown below) to help determine entry based on when you think price may revert back to its average price.

Caveat: VWAP can be applied to different time periods. So, if you’re trying to increase your chances of not trading against larger institutions, note that some firms may be using shorter-term time periods while others may be using longer-term periods.

In short, VWAP is no guarantee that you’ll be avoiding a “whale”, but it does give you some insight as to where these whales might be spotted.

Customizing Your VWAP Strategy

You can customize your VWAP indicator to a specific time period.

In the example above, I narrowed my time frame to just a few hours of trading. As I demonstrated, you can use the customized VWAP as a tactical tool to analyze average prices within a preferred time frame. However, if you are trying to analyze average prices alongside institutional players, bear in mind that they may not be using the same time frame as you.

So although traders use VWAP to increase their odds of trading with the bigger players, just remember that customizing your VWAP will set the context strictly within your own preferences, which can be useful when personalizing your strategy.

3 –  Volume Profiles: Decipher Market Structure and Trading Activity

Let’s take a step back for a moment and think of a familiar non-market scenario. Let’s think about our local geographical areas. There are certain places people frequent. Grocery stores, restaurants, and other social areas.

This volume of traffic tells you something. People frequent these areas for a reason. These high-traffic areas hold a degree of importance that either attracts people or makes them come back (for one reason or another). When it comes to price levels, a similar principle applies.

Pioneered by J. Peter Steidlmayer, the Market Profile chart aimed to analyze price activity as it evolved throughout the trading day.

There’s a lot to market profile charts, and we can’t even begin to discuss it here. But one simple way to look at it is to note areas with the largest horizontal lines. Those lines represent the amount of trading activity at a given price level.

As traders collectively go through the motions of “price discovery,” there are certain price levels at which buyers and sellers might agree on, in terms of a temporary “equilibrium” in value. These are called “value areas,” and they are often the most frequented levels.

Value areas will change from day to day as the market digests new information. Value areas will also take different shapes and forms depending on the price discovery process.

As you trade with a given Profile, you have to interpret what these trading areas mean, and whether they might indicate support and resistance, breakout levels, or price targets.

And with Optimus Flow, you can customize your Volume Profiles by analyzing different time frames, or even place multiple profiles at once–setting one at the center, left, and right of your chart. We will cover the details of this fascinating indicator in a later post.

4 – Time and Sales Window: Classic Tool for Historical Trade Analysis

Ever wondered what old fashioned ticker tape reading was like? Well, the Time and Sales window is probably the closest you will get to it.

Not so much an indicator as a historical record of trades, time and sales displays all trades for a given instrument, detailing price, quantity, date, and time.

Unlike the past, where trades were dispensed in a seamless row of tape printouts, today’s digitally powered trades hold much more volume and speed, especially in real-time, where the data flows like a ticker tape on steroids.

Nevertheless, time and sales data can be a treasure trove for those who know what to look out for.

So, what’s the point of reading Time and Sales? Similar to the Power Trades scanner, you are looking for aggressive trades that might indicate stronger buying or selling pressure.

Except, unlike Power Trades, you are sifting through all of the trade data by sight.

Tape reading is no easy task, and it is a skill that takes practice. But if you can master it, you might have an edge over other traders who are unfamiliar with this long-forgotten practice. You have to admit, it’s pretty “old school”.

5 – Time Statistics: Detailed Insights into Market Behavior Per Candle

The Time Statistics window provides comprehensive volume data for each bar or candle. Key insights include the volume in the last bar and the count of buy and sell trades.

These statistics help traders understand how volume influences market price movements.

These are all questions that the stats data can answer. It is like another way of monitoring the Time and Sales. But instead of following a running history of trades, you can see the data evolve as each bar forms.

6 – Time Histogram: Comprehensive Volume and Trade Analysis

The most common histogram that we are used to seeing, possibly because every chart has it, is a volume histogram.

Volume histograms are quite useful as they provide a relatively clear picture of volume trends (or lack of) and buying/selling pressure. But what if you wanted more information?

For instance, what if you wanted to know the total volume, buy or sell volume, buy and sell volume, average buy or sell side, or what if you wanted to filter your volume information?

Getting this level of detailed information is what makes Optimus Flow’s Time Histogram very useful, as you have a list of data choices you can display on your screen.

For instance, here is a Time Histogram displaying buying/selling volume. Again, this is just one set of data that can be displayed in a histogram format.

Depending on the kind of data you choose to see, you can customize the histogram’s settings to analyze historical trading activity or to forecast potential turning points in the market.

7 – Cluster Chart: Advanced Visualization of Intraday Market Depth

Also known as a “footprints” chart, the Cluster Chart allows you to get an in-depth view into what is going on inside a candle. What is the order flow like in terms of total trades, buy or sell trades only, trading volume, etc.? There are several different settings you can use to filter the candle information.

Why use the Cluster Chart? So, you can get insight into zones of maximum buying or selling, zones of high trading interest, or indications of aggressive buying and selling activity.

These bursts of short-term momentum can often determine the coming price direction. Aggressive buying pressure may indicate that there are more buyers than sellers in the room; aggressive selling pressure may indicate the opposite scenario.

If you can identify areas of high trading interest, you may be able to pinpoint zones of support and resistance, both of which also can serve as breakout points when buyers outnumber sellers or vice versa.

What you are viewing is the dynamics of the order flow for each individual candle, the “footprints” that have caused the price to move in a given direction, and the current footprints that may cause a similar reaction moving forward.

Further Reading: How to Identify Imbalance in the Markets with Order Flow Trading

The Bottom Line

Order flow drives the inner dynamics of price movement. And the essential information contained in order flow is the amount of buying pressure or selling pressure within a given window of time.

With specialized indicators designed to observe buying and selling pressure, you can get a unique view toward price action that many other traders may not be able to see. You can see order flow–a dynamic that most traditional technical indicators are incapable of representing.

Ultimately, this can provide you with a potential trading advantage, particularly if you develop your own unique approach toward integrating this analysis and set of tools into your trading style.

There is a substantial risk of loss in futures trading. Past performance is not indicative of future results. When considering technical analysis, please remember educational charts are presented with the benefit of hindsight. Market conditions are always evolving, and technical trading theories and approaches may not always work as intended. .

This article on Order Flow Analysis is the opinion of Optimus Futures. 

Editor’s Note: This article was originally published on August 6th, 2016 and has been updated for comprehensiveness.

For more than a century, standard methods of market analysis for stocks and commodities have centered around two types: technical analysis and fundamental analysis.

While both methods have their unique methods and differences, neither has observed the significant impact of real-time supply and demand—in the form of orders and transactions—on market prices.

The reason for this was technological: before the 21st century, no machines could compile the flow of orders and transactions in real-time across multiple exchanges.

But as the digital age dawned, access to this information on a large scale became possible. Out of this new capability came a new form of market analysis: order flow analysis.

What is Order Flow Analysis?

Order Flow Analysis is a type of market analysis that examines the real-time sequence of trades in a given market to determine how the sequence might affect prices in the near term. In other words, analyzing order flow is about observing the transactional mechanisms that move prices.

There are a few methods and tools you can use to analyze order flow. Let’s start with the most basic and accessible tool: the DOM chart.

Two Methods to Analyze Order Flow: DOM and Cluster Charts

For analyzing order flow, two main tools are Depth of Market (DOM) and Cluster charts.

• DOM shows live orders waiting to be filled, like a list of upcoming buy and sell actions. It’s like watching orders line up, showing you where people want to buy or sell but haven’t yet.

• Cluster charts give a replay of trades that already happened. They break down the action, showing at which prices trades were executed and how many.

So, while DOM is about the future—orders waiting to go through—Cluster charts are about the past, giving insights into what’s already happened.

So, let’s delve into both methods, starting with DOM.

Order Flow Analysis Method 1: DOM (Depth-of-Market)

The simplest method to analyze order flow is observing the interplay between the Depth of Market and Market Orders. This interplay reveals, in its most naked form, the Order Flow in a given market (we used Optimus Flow trading platform for the illustrations).

Take a look at the figure below:

Order Flow Figure #1:  The E-Mini S&P 500 DOM ( Optimus Flow Trading Platform)

The Current Price is the last price in which a trade took place. This last trade could have taken place either at the Best Bid Price or at the Best Ask Price.

The Depth-of-Market (DOM) is the total size of Limit Buy (Bid) or Sell orders (Ask) that are placed at each price. It is often called Liquidity, Limit Orders, Passive Orders, or simply, The Book.

If you look at the DOM example above, it looks like a price ladder. Because the DOM is also a tool to place trade orders, its proper name is DOME (Depth of Market Execution), but most traders just call it the DOM in both cases.

The Left Column shows the prices while the Right Column shows the 10 Bid levels and the 10 Ask levels.

The numbers in the Bid and Ask column tell us how many contracts (or stocks or lots) are waiting as limit buy orders (Bids) or as limit sell orders (Asks) at each price.

Why Only 10 Bids and 10 Asks?

Different exchanges supply data about a different number of Depth of Market price levels. With futures contracts, we usually get 10 levels of Bids and 10 levels of Asks in a standard DOM feature.

In other words, there are likely more orders placed above the 10 Ask levels and below the 10 Bid levels but we can’t see them.

The Point of Transaction (where orders are filled)

Note the Best Ask price, which is the lowest of the 10 Ask levels, and the Best Bid price, the highest of the 10 Bid levels. This is where orders are executed (filled).

In Figure #1, we see that the current price is at the Best Bid price (indicated with the small black triangle). This means that the last trade happened at the Best Bid price.

IMPORTANT POINT: No matter how many contracts are limit orders waiting at the Bid or Ask levels, no trade will ever take place until a Buy or Sell Market order is placed.

Market Order means “fill my buy or sell order  NOW at the best price.” In other words…

• When a trader places a Buy Market order, he announces that he wants to buy X contract right now at the Best Ask price. Buy Market orders are always matched against the Sell Limit orders waiting at the Best Ask price.

• When a trader places a Sell Market order, he announces that he wants to sell X contract right now at the Best Bid price. Sell Market orders are always matched against Buy Limit orders waiting at the Best Bid price.

This sort of explains why the highest of the bid levels is called the Best Bid and the lowest of the Ask levels is referred to as the Best Ask.

• When a trader wants to sell at the market (sell with a Market order) he/she intends to sell at the highest price available, so the highest bid price is his best option.

• Likewise, when a trader wants to buy at the market he wants to buy at the lowest possible price, and therefore the lowest ask price is his best option.

A market participant (buyer or seller) would want the tightest Spread between the Best Bid price and the Best Ask price. The tighter the spread, the more liquid a market is. In contrast, less liquid markets tend to have a wider spread between the bid and the ask.

While the DOM is one of the more common ways to visualize the order flow, there’s another tool we have that you can use for order flow analysis: Cluster charts, aka footprint charts, or number bars.

Order Flow Analysis Method 2:  Cluster Charts

Cluster charts, also called footprint charts, are a type of charting that shows the volume of trades executed at specific price levels within a candlestick.

This gives you a deeper understanding of market dynamics, including the balance between supply and demand, areas of high liquidity, and potential price movement directions.

Cluster charts allow you to analyze the flow of market orders and the volume of trades at particular price levels. Using this information, you can infer the immediate sentiment of the market which, in turn, can help you predict short-term price movements.

By revealing imbalances between buyers and sellers, cluster charts can also highlight potential areas of support or resistance in addition to hinting at potential market directionality.

So, how does it work? Let’s take a look at the following image:

Order Flow Figure #2: Cluster Charts (Optimus Flow Platform)

Order Flow Figure #2: Cluster Charts (Optimus Flow Platform)

Figure #2 shows a 5-minute Cluster chart (Optimus Flow). The numbers at each price show Bid Volume x Ask Volume.

The Bid Volume is – The number of Contracts/Stocks/Lots that were sold with market orders when this specific price was the Best Bid price.

The Ask Volume is – The number of Contracts/Stocks/Lots that were bought with market orders when this specific price was the Best Ask price.

Don’t confuse Bid Size/Ask Size with Bid Volume/Ask Volume! Volume in this context means “executed orders.” “Size” on the other hand refers to “pending orders.” This distinction is pivotal, with Volume providing insights into past market activity and Size offering a glimpse into the market’s immediate future through open orders.

So, while the DOM shows the limit orders that are waiting to get filled the Cluster charts show what traded at each price.

So what makes the price move? Look at the next figure which shows both the cluster chart and the DOM.

Order Flow Figure #3: A DOM attached to a Cluster chart (using Optimus Flow platform)

Order Flow Figure #3: A DOM attached to a Cluster chart (using Optimus Flow platform)

We see that at the moment this screenshot was taken we had a total of 4 contracts waiting as buy limit orders at the Best Bid price 3596.25 and 2 contracts waiting as sell limit orders at the Best Ask price 3596.75.

The current price is 3596.50. Figure #3 is static but we have to remember that the numbers on the DOM keep on changing all the time because of two reasons (look for the second in the next section):

Reason # 1: When a trader places a buy market order of X contracts, we will right away see a reduction of contracts from the Ask Size at the Best Ask price on the DOM and addition of contracts to the Ask Volume at the Best Ask price on the Cluster chart.

When a trader places a sell market order of X contracts, then we will right away see a reduction of contracts from the Bid Size at the Best Bid price on the DOM and addition of contracts to the Bid Volume at the Best Bid price on the Cluster chart.

Example – In Figure #3 we have 2 contracts at the Best Ask price (3596.75).

If at this moment a trader places a buy market order of 1 contract we will right away see that the Ask Size will change to 1 because the buy market order of 1 contract was matched with 1 of the 2 contracts that were waiting as sell limit orders at 3596.75 and they got filled leaving 1 contracts still waiting to get filled against new buy market orders.

On the Cluster chart, we will see that the contracts that were bought so far with market orders at the Best Ask price will change because 1 more contract was just bought at the market.

On the Bid side, we have 4 contracts at the Best Bid price (3596.25). If at this moment a trader places a sell market order of 1 contract we will right away see that the Bid Size at 3596.25 will change to 3 because the sell market order of 1 contract was matched with 1 of the 4 contracts that were waiting as buy limit orders at 3596.25 and they got filled leaving 3 contracts still waiting to get filled against new sell market orders.

On the Cluster chart, we will see that the contracts that were sold so far with market orders at the Best Bid price 3596.25 will change because 1 more was just sold at market.

Reason # 2: The second reason for the continuous change of the Bid Sizes and Ask Sizes on the DOM is that traders add limit orders and cancel limit orders. Some of the adding and canceling have to do with legit trading decisions, and some reflect manipulation efforts (Spoofing).

So far we understood how price fluctuates between the Best Bid and Best Ask. The next question to ask ourselves is – What is required for the price to move one tick higher to the next Best Ask price or one tick lower to the next Best Bid price?

Order Flow Figure #4:

In figure #4, we see the 2 contracts waiting as limit sell orders at the Best Ask price of 3596.75.

If at this moment traders buy 2 contracts at market then all 2 contracts waiting at the Best Ask price will get filled and we will have zero contracts at 3596.25 which will immediately make 3596.75 the new Best Ask price and the next buy market orders will be matched with sell limit orders at the new Best Ask price 3596.75.

The same story applies to the downside. We need 4 contracts to be sold at the market to get the entire buy limit orders at the Best Bid price of 3596.25 filled and then the next sell market orders will be matched against limit buy orders at the new Best Bid price of 3596.00.

In liquid markets, there are always limit buy orders waiting at the next bid price of sell limit orders waiting at the next ask price, and therefore price moves in one tick jumps.

With less liquid markets the next Best Bid price or next Best Ask price may be more than one tick away, and we may see price jumping more than one tick leaving some price levels untraded behind.

The spread will almost always remain 1 tick in liquid markets (in our experience) because as soon as the Best Ask jumps one tick to the upside traders will quickly place buy limit orders at the level that was the previous Best Ask and is now available for the bids.

Or as soon as the Best Bid jumps one tick to the downside traders quickly place sell limit orders at the level that was the previous Best Bid and is now available for the asks.

During important economic data releases or news events, traders tend to withdraw limit orders, and the book becomes much “thinner” and then even in liquid markets, the spread may increase to more than one tick for a very short time.

Appendix #1 – Advanced Features of the Optimus Flow DOM.

Figure #5 shows the Optimus Flow Chart DOM with a few additional features. You can see 2 new columns.

Figure #5:                                                                           

The column on the left shows the resting limit orders for the Best Bid price. It sits at 4 contracts. The column on the right shows the resting limit orders for the Best Ask price, it sits at 2 contracts.

If you notice that the Best Ask price is colored at half the length of the Best Bid price. This is because it is in histogram mode.

It is an easy way to visualize whether there are more bids or more asks, in other words; buying vs selling pressure.

Appendix #2 – Advanced Features of Optimus Flow Cluster Charts

Figure #6:

The Cluster chart in Figure #6 displays a few advanced features. The green and red fonts alert us that the diagonal comparison between the Ask Volume, when a price was the Best Ask and the Bid Volume at the accordant Best Bid price, gives a ratio value that is larger than a specific threshold value ( 3 in this case).

The comparison is called an imbalance because the Best Ask price is on the right side of the “x” and is (usually) one tick higher than the Best Bid price on the left side of the “x”. If the Ask Volume is larger than the Bid Volume, then the color is green, and if vice versa is red.

The Numbers Bars are overlaid on top of Volume Profiles which gives us a good visualization of the volume distribution within each bar.

Optimus Flow offers all these tools and more for free when you sign up with Optimus Futures Brokerage. Take advantage of all the order flow tools absolutely free for all customers.

The Bottom Line

Order Flow Analysis can offer a cutting-edge perspective on the markets, shedding light on the real-time forces of supply and demand through the analysis of transaction flows.

This method, distinct from the traditional technical and fundamental analyses, leverages digital technology advancements to track and interpret live data on orders and transactions.

With tools like Depth of Market (DOM) and Cluster Charts, you can now peer into the future with DOM’s live order queues or delve into the past with Cluster Charts’ historical trade data.

DOM provides a forward-looking view by displaying pending buy and sell orders, while Cluster Charts offer a retrospective analysis, showing executed trades at specific prices.

You need both tools to gain a comprehensive picture of the markets when doing an order flow analysis. Both allow you to decipher market dynamics, see potential support and resistance, and anticipate price movements.

As you learn to use these technological enhancements, you may unlock new dimensions in market analysis that enable you to gain a deeper understanding of what drives price changes and where they might be headed. Happy trading!

There is a substantial risk of loss in futures trading. Past performance is not indicative of future results. When considering technical analysis, please remember educational charts are presented with the benefit of hindsight. Market conditions are always evolving, and technical trading theories and approaches may not always work as intended.

Attention Traders,

For your advanced planning, please refer to the following table for the upcoming Good Friday and Easter Holiday Schedule for the dates of 3/28/24 – 3/31/24:

Thank you for your prompt attention to these matters and we wish you a happy holiday! If you have any questions, please contact us at: (800) 771-6748 or send us an email at: support@optimusfutures.com

Attention Traders,

Please refer to the following table for the Martin Luther King Day Holiday Schedule for the dates of January 12, 2024 – January 15, 2024:

Thank you for your prompt attention to these matters! If you have any questions, please contact us at: (800) 771-6748 or send us an email at: support@optimusfutures.com

Attention Traders,

Please refer to the following table for the 2023 Christmas and 2024 New Year Holiday Trading Schedule:

Thank you for your prompt attention to these matters and happy holidays from the team at Optimus Futures!

If you have any questions, please contact us at: (800) 771-6748 or send us an email at: support@optimusfutures.com

The article on Fair Value Gaps is the opinion of Optimus Futures, LLC.

• Fair Value Gaps (FVGs) are price jumps due to imbalanced buying and selling pressures, viewed by traders as opportunities amidst market uncertainty.
• FVGs can be spotted on charts as large candles not fully overlapped by the wicks of neighboring ones, differing from small gaps that don’t show significant buying/selling imbalances.
• Trading strategies for FVGs involve buying/shorting the gap, using FVGs as support/resistance levels, and implementing various indicators and stop losses.

What Are Fair Value Gaps?

A Fair Value Gap (FVG) as it’s often referred to, is basically a gap that forms when the buying and selling forces are wildly out of balance.

What causes this mismatch? Well, it could be a ton of things – a major news event, the release of certain economic data, or even hefty trades by big institutions. Does that make sense?

Let’s talk about how price action traders view Fair Value Gaps or FVGs. They often see these as chances to jump into the market, banking on the likelihood that the market will swing back to cover the gap before it carries on in the direction it was originally heading.

But here’s a word of caution – FVGs can sometimes act like pitfalls. There might be instances where the market doesn’t fill the gap and instead continues on its original path.

ALSO READ | How to Trade Price Gaps

But What Does “Fair Value” Even Mean? Good question. To really get how FVGs form, it helps to understand the idea of ‘fair value.’

Now, fair value is the price point where a security would be trading if the buying and selling forces were perfectly balanced. But when there’s an imbalance, that’s when the market price begins to drift away from this fair value.

In an FVG scenario, the market price will create a gap, either upward or downward, to a level that’s closer to the fair value.

Why does this happen? It’s because the imbalance in buying and selling pressures will eventually find a way to correct itself.

What Do FVGs Tell You?

FVGs indicate that there is a significant imbalance in buying and selling pressure. This imbalance can be caused by a number of factors, such as:

• News events: If there is a major news event that causes a sudden change in market sentiment, this can lead to an FVG. For example, if there is a surprise interest rate hike, this could cause the market to gap down.
• Economic data releases: Similarly, if there is a major economic data release that causes a sudden change in market sentiment, this could lead to an FVG. For example, if GDP growth is lower than expected, this could cause the market to gap down.
• Large institutional trades: Large institutional trades can also lead to FVGs. For example, if a large hedge fund is buying a large number of shares of a stock, this could cause the market to gap up.

This kind of uncertain environment can actually pave the way for opportunities for traders, particularly those who rely heavily on price action.

But like everything else in trading, it’s crucial to keep in mind the risks involved. You know what they say, right? “No risk, no reward”, but always be mindful of that risk part.

How To Identify Fair Value Gaps Gaps (and what are not FVGs)

FVGs can be identified on a chart by looking for a large candle whose neighboring candles’ upper and lower wicks do not fully overlap the large candle.

The space between the wicks of the neighboring candles is the FVG.

FVG

It is important to note that not all gaps are FVGs. For example, if there is a gap between two candles that are both very small, this is not an FVG.

This is because the imbalance in buying and selling pressure is not significant enough to create an FVG.

Not an FVG

Here are some of the key characteristics of FVGs:

• They are created by a significant imbalance in buying and selling pressure.
• They are often large gaps, spanning multiple candles.
• They can be found on all time frames, but they are most commonly seen on daily and weekly charts.
• They can be filled or not filled.

Basically, you’re on the lookout for a large candle on a chart that’s not fully covered by the wicks of its neighboring candles – that space in between is your FVG.

Remember, not every gap is an FVG. For instance, a gap between two tiny candles isn’t one, because the buying and selling imbalance isn’t enough to make an FVG.

Key things to remember about FVGs:

• they’re formed by a significant buying and selling imbalance,
• they’re usually big spanning multiple candles, they’re found on any time frame (though mostly on daily and weekly charts), and
• they can either be filled or remain unfilled.

Strategies for Trading Fair Value Gaps

There are a number of different strategies that can be used to trade FVGs. Some common strategies include:

Buying the gap: This is the most common strategy for trading FVGs. The idea is to buy the market at the price level of the gap, and then sell it once the market retraces back to the gap.

ES – 1-hour chart 7.7 to 7.13.23.

In this example, a trader could have used multiple exit strategies to take profits.

Shorter term traders might have taken a measured move approach, waiting for the position to reach a certain percentage of the amount risked (e.g. 2-to-1 reward/riask), Longer term traders might be aiming at the 4630.00 (March 2022) high.

Shorting the gap: This strategy is less common, but it can be profitable if done correctly.

The idea is to short the market at the price level of the gap, and then cover the short once the market retraces back to the gap.

GC Daily Chart 4.11 to 7.4.23. Chart illustrates the FVG, retest, and profit target using the measured move method.

Using FVGs as support or resistance: FVGs can also be used as support or resistance levels.

For example, if a market gaps up and then retraces back to the gap level, this level can often act as support in the future.

Additional Tips for Trading FVGs

• Use a combination of indicators: It is often helpful to use a combination of indicators to trade Fair Value Gaps. This will help to confirm the trade and reduce the risk of false signals.
• Use stop losses: It is important to use stop losses when trading Fair Value Gaps. This will help to protect your profits and limit your losses.
• Wait for confirmation: Before entering a trade, it is important to wait for confirmation that the market is actually going to retrace back to the gap. This can be done by looking for a bullish or bearish reversal candle at the gap level.
• Be patient: Trading Fair Value Gaps can be a patient game. It is important to be patient and wait for the right trade before entering.

The Bottom Line

Fair Value Gaps (FVGs) are price jumps that happen when buying and selling pressures are not balanced, caused by things like big news, economic data releases, or large institutional trades.

Traders see these gaps as a sign of market uncertainty and potential opportunities.

However, they can also be risky, as the market might not always cover the gap. You can spot FVGs on a chart as large candles not fully overlapped by the wicks of their neighbors.

Not all gaps are FVGs; small gaps, for example, do not signal a significant buying and selling imbalance.

When trading FVGs, common strategies include buying or shorting the gap, and using FVGs as support or resistance levels.

It’s also advised to use a mix of indicators, stop losses, wait for confirmation, and be patient when trading FVGs. Understanding these can help you navigate the market better, but always consider the risks.

Trading in futures involves a significant risk of loss and is not suitable for all investors. Past performance is not necessarily indicative of future results.

The article on Mean Reversion Trading is the opinion of Optimus Futures, LLC.

• Asset prices often tend to revert back to an established mean after an extreme move.
• Successful application of this principle in trading requires patience and skill.
• Continuous adaptation is critical when trying to fade markets.

It doesn’t guarantee a snap-back in price; sometimes the model will just break and prices will run. But when it does work out, the rubberband makes for a good metaphor for this model. Enter Mean Reversion Trading.

Just as the name suggests, mean reversion trading revolves around the idea that asset prices have an average or “mean” level to which they tend to return.

Another metaphor to help you understand this concept is the pendulum. It swings to the left, then the right, but always seems to find its way back to the center.

You’re probably wondering: “Is it really that simple? Can I just wait for an asset to swing away from its mean and bet that it’ll swing back?” Well, yes and no.

While the concept itself is straightforward, applying it effectively in the market requires a keen eye, discipline, and a nuanced skills to manage the trade, especially if it doesn’t work out.

So, let’s dive deeper and explore this method of trading. By the end of this article, you’ll have the basics down and maybe even develop a few strategies along the way. Let’s start from the beginning.

What is Mean Reversion Trading?

Mean Reversion Trading is a trading strategy based on the assumption that assets tend to gravitate toward their historical average values over time.

When prices deviate significantly from its average or ‘mean’ price, it tends to to revert to its historical norm.

Traders take advantage of this—either buying or selling—to catch the move back towards its average value.

Why Does Mean Reversion Trading Deserve Your Attention?

There’s an age-old adage in the trading world: “Markets ascend the stairs but plummet down the elevator.”

This essentially captures the swift pace at which prices can drop compared to their gradual rise. And for those intrigued by mean reversion trading, this dynamic is pure gold, presenting lucrative trading windows.

Trend-following might be all the rage, but it’s not everyone’s cup of tea.

It’s crucial for traders to resonate with a strategy that aligns with their personal temperament and cognitive style.

For those who get antsy during the snail-paced climbs of trending markets, the brisk nature of reversal trading could be a refreshing change.

That said, mean reversion isn’t for the faint-hearted.

If market volatility sends your heart racing or if you’re prone to making spur-of-the-moment trade decisions, this method might prove challenging.

Reversals can be unpredictable, marked by significant momentum and volatility. So, as with all things in trading, know your limits before diving in.

What Are the Theoretical Assumptions Behind Mean Reversion Trading?

The main assumptions are as follows:

• Law of Averages and statistical principles: The law of averages suggests that outcomes will eventually balance out to reach a “normal” state, or, better yet, an average. In trading, if prices move significantly from its average price, it will inevitably revert to that average over time.
• Market equilibrium: If you know anything about economics, you’ll understand that financial markets always reach a temporary state of equilibrium. When does this happen? It’s when buyers and sellers agree on the price of a given asset; when price is not too expensive and not too cheap.
• Historical vs. statistical mean reversion: Historical mean reversion considers past price behavior of an asset to determine its mean, while statistical mean reversion uses mathematical models and standard deviations to identify potential mean reversion points.

What Are the Key Characteristics of Mean Reversion?

Before jumping into the market for a quick top or bottom fade, here are three characteristics you should consider.

1 – Overbought and oversold conditions: Are you certain that an asset has entered overbought or oversold territory? If so, what methods are you using to confirm that assessment?

2 – Role of volatility: How volatile was the move toward the extreme end of that overbought or oversold level? If volatility didn’t play a role, then you run the risk that price can jump against your position. And that could lead to a whopping loss.

3 – Understanding the phase of reversion: Are you trading a trend reversal, a reversion in a wide trading range (sideways market), or a correction within a larger trend? You should have a good sense as to where and when prices might reverse against your direction in case you need to manage your trade or make a quick exit.

So, what tools might help you fade the market a bit more effectively? Here are a few to consider.

Indicators and Strategies for Mean Reversion Trading

Moving Average Convergence Divergence (MACD): The MACD can help you spot divergences, but it also has a lot of false signals.

To avoid this, pay attention to the larger price context, and enter a trade only upon confirmation, which often means a pattern breakout or a breakout from either support or resistance.

In the example above we saw divergence between the MACD form over several candles.

Still, this isn’t enough to signal a short trade, as the MACD is notorious for given false divergence signals.

So, what we do is wait for confirmation. Once price broke below the most recent swing low, it was a signal to go short the market.

Some traders thought that the swing low would have served as support, but that’s where the MACD divergence came into play.

It signaled that price was about to move lower (not necessarily to the average, but more a trend reversal). As far as averages are concerned, the next indicator was designed to do just that.

Bollinger Bands: These consist of a middle band and two outer bands typically set to 2 standard deviations.

Prices that touch or move outside these bands might indicate overbought or oversold conditions, respectively, and they tend to bounce back toward the middle band representing the average. Let’s take a look.

The example above shows exactly what Bollinger Bands are designed to indicate. Here, prices spiked upward with multiple closes above the upper band.

Considering that the upper band represents two standard deviations. The chances of a correction are high. But how deep might the correction go is something that we couldn’t predict.

A good trade setup would have been on the down candle after the highest swing point.

A short entry upon the breakout of that candle with a stop loss above the highest high would have been the smartest way to fade this market. As you can see, prices eventually reverted back to the moving average the following candle.

Relative Strength Index (RSI): This momentum oscillator measures the speed and change of price movements.

An RSI above 70 suggests overbought conditions, while below 30 indicates oversold conditions. Take a look the chart below.

The oversold reading in the RSI made for a perfect entry point to catch the rally.

You’ll notice that the buy signal was a breakout of the smaller congestion area following the drop. A stop loss would have been placed below the lowest swing low point.

Stochastic Oscillator: This metric compares a particular closing price of an asset to a range of its prices over a certain period. Like the RSI, it can help identify overbought and oversold conditions.

The example below shows a quick scalp using stochastics.

Prices were hovering in overbought territory as it continued to rally for several candles.

What drew a trend line and waited for prices to fall below it. Fortunately, the trendline break coincided with a decline in the stochastic reading as well.

After entering a short trade, we would have exited that position once price bounced back after entering oversold territory.

Pinpointing vs Approximating Tops and Bottoms

One of the biggest challenges many newbie traders face when dabbling in mean reversion trading is the urge to pinpoint the exact moment a trend will reverse.

It’s like trying to predict the precise moment when a pendulum will swing back. This doesn’t work, at least not consistently enough for you to continue attempting it.

Savvy mean reversion traders know better than to play this prediction game. Instead, they’re on the lookout for signals that a trend is genuinely losing its pep, indicating an imminent shift.

Hunting for the utmost peaks and valleys is NOT the name of the game in mean reversion.

It’s fraught with risks and can lead to missteps. Instead of trying to nab the highest highs or the lowest lows, a wise trader observes, waits, and jumps in only when the tide has undeniably turned.

Think of it this way: be a follower of reversals, much like trend-followers track trends.

A trend follower wouldn’t prematurely declare a new trend but would instead wait for it to solidify, the same patience and strategy apply to reversal trading.

Same thing goes with mean reversion. All of the examples above demonstrate this approach of waiting for confirmation and not just blindly jumping in.

Don’t Forget to Manage Your Risks

Risk management is essential because no strategy guarantees success every time. By properly managing risk, you can withstand losses and still remain in the game.

One way to manage risk in this arena  is to identify false reversions. False reversions occur when a price seems to be reverting to its mean but then continues its trend. It is important to recognize and avoid these false signals to avoid losses. When you can’t, however, that’s what your stop loss is for.

Another way to manage risk is to size your positions appropriately. Never overexpose your capital by investing too much in a single trade. Don’t bet the farm on a trade, so to speak.

Figure out the right amount to risk and don’t commit anything more than that.

Finally, it is important to set stop-loss orders and profit targets. This is self-explanatory, and we’re certain you know it.

It’s not discussed much but another risk factor is, believe it or not, yourself, as in your frame of mind and trading psychology. Let’s tackle this next.

Psychological Challenges and Biases

Don’t let a few wins go to your head. Just because you hit a couple of home runs doesn’t mean you’re invincible. Keep your feet on the ground and stay true to your game plan.

When it comes to playing the waiting game, think of it as fishing. The big catch might not bite right away.

Give it some time; patience can be your best buddy in this. You can’t force a trade. You have to wait. Might as well develop patience, right?

Beware cognitive biases. If you don’t know what those are, then look it up.

Traders often fall prey to biases like confirmation bias, where they seek information that aligns with their beliefs and ignore contradictory data.

There’s plenty more too, so educate yourself with regard to this challenge.

The Bottom Line

Mean Reversion Trading is all about riding the correction up or down from an extreme price move. To do it well, you have to really know your stuff.

You need the right skills and the right mindset to allow such a strategy to work.

So, always be on your toes, learn from each trade, and be ready to change up your game if needed. Happy trading!

Trading in futures involves a significant risk of loss and is not suitable for all investors. Past performance is not necessarily indicative of future results.