Order Flow Catching The Edge And Icebergs
I mean it’s a good cookie right? Totally worth 10 bucks…Oh hey you’re back!
Good because I have so much more I want to teach you guys. In fact, I think this series will have more videos than I originally intended. Today I want to give you some real tangible edge, and we’re going into detail too. So even some of you old hats might get something out of it. We’re going to cover two setups that can give you more favorable entries — catching the edge and icebergs. You know those trades where price never goes even a tick against you? These edges can help you catch more of those. Now I don’t want to oversell it. The edge these setups give you on their own is tiny. They’re more about optimizing your entries when you’re making a trade based on a larger edge. However, what makes these setups special is that they are structural edges. That means that they take advantage of inefficiencies caused by the very rules of the market. So not only can we prove they are edges through simple math and logic, but we can know that these edges will always exist unless the structure of the market changes. That makes these two setups the perfect foundation for understanding orderflow because it’s getting down to the heart of how the game works. Also we’re finally going to put this high quality chalkboard to use so I’m excited!
By the way, thank you so much to everyone that watched and commented on the first video in this series. It’s tracking to be one of the top videos on the channel so keep it up. The engagement is a big part of that so make sure to ask questions and leave your own tips about icebergs and catching the edge in the comments below. With your help we’re creating possibly the best resource on this subject out there so keep it up. Also, I’d love to know what you think about the chalkboard setup. I’m using a different mic and everything so I can move around a bit. So let me know what you think of it. Anyways I have a picture of my Jigsaw DOM drawn up here. If you are not familiar with what all these columns are, please refer to the first video in this series. I should also note that not all software has the middle current trades / market orders columns. It’s mainly a Jigsaw thing although you can duplicate it in SierraCharts and others. If you don’t have these columns you’ll have to watch the volume profile to determine how much traded. Obviously it’s a lot easier to just have the column which is part of why I love Jigsaw so much. And as always I want to note that I am a Jigsaw affiliate. If you purchase the software through the link in the video description I get a commission that helps grow the channel.
So let’s start with our first example. This is what you’ll usually see on the DOM. Here we have the current best bid and best offer. Since these are the prices that market orders will be matching against there is considerable interest around them. Usually there’s less limit orders at these prices, and one side will be stronger than the other. This is important because that affects how likely those orders are to get filled.
In our current example there’s way more orders on the bid than on the offer. So think about it, if everything else is equal, what is more likely to happen? That 500 orders come and lift the offer, or that 3000 orders come and smash the bid? We are more likely to tick up because it will require less orders for it to happen. The smaller that offer is, the more likely it is to get taken out to a point where it’s practically guaranteed to happen. So knowing this traders will buy into that 500 on the theory that all the orders will be taken out causing the price to tick up. This is called catching the edge. You’re buying just as price is about to leave. Hopefully a bid will form behind you, and now you have the option to sell at the price you just bought to scratch the trade if you need to.
See, normally using a market order has a disadvantage. You’re giving up the spread. If you buy with a market order and price doesn’t tick up then you have to lose a tick to get back out. That might not seem like a big deal, but it can make a huge difference. You’d think that if you just took a random trade with equal risk reward that you’d have a 50% chance of winning on the trade, but because of the spread it’s really more like 45%. When we’re able to catch the edge we’re canceling out that disadvantage, and turning it back into more of a 50/50.
Now of course, for you to actually make money after that it has to keep going right? Otherwise it’s just the opposite situation. The offer is larger than the bid and we tick back down. So after we tick up we want to see continued pressure. That means some combination of orders adding on the bid behind us — what I call stacking, orders at the next offer cancelling or pulling, and market orders starting to hit into the next offer. Now you can’t guarantee that you’ll see that continued pressure. The traders that moved the price up don’t necessarily know anything. They were just trying to catch the edge. However, if you’re going to take a trade it’s always to your advantage if you catch the edge. So what we want to do is combine this with other larger edges that we have. For instance, news and sentiment that gives us a clear read on what direction we should move on the day. Then we’re more likely to see that continued pressure after getting in, and if we don’t see it we just scratch.
Often though the problem will be more about being fast enough. That’s where again Jigsaw is just awesome and has a feature called a volume stop. This is an order that will trigger if the queue at that price goes below a certain threshold. So if the queue goes below 500 then the order will trigger and hit into that price. For catching the edge I’d recommend setting it to trigger a stop limit order. That way if the liquidity gets taken out before your order is submitted you’ll just submit a limit order onto the new queue, rather than hitting into the next price. If you miss you’ll at least be at the front of the queue with a better chance of being filled. From there it’s a matter of deciding what threshold to use. For that you’ll find that the queues have tendencies to balance at certain levels. There’s actually some math behind why this happens, but we don’t need to go into that. You’ll see it very clearly as you watch the action. In the 10 year treasury 2000 is fairly stable. If we get below 1600 we’re more likely to see price change, and below 500 we’re extremely likely to see price change. So you can set your threshold at a random number between those levels based on how concerned you are about getting left behind. Don’t pick a number that’s too obvious though. Part of the game is market makers constantly stacking and pulling to see if they can get orders to trigger prematurely.
And you really do have to think of it like a game. It’s like rock paper scissors where you have a constantly evolving metagame. All this time though we’ve been talking about rock. The move that almost everyone picks their first time playing. So what is paper? Say you see 500 lots on the offer. You want to catch the edge so you and 500 other lots hit into it, but the price doesn’t tick up. Instead another 500 lots have been added to the offer. You’ve just run into a refreshing or iceberg order. This is a limit order where only a portion of the order is shown at a time. As that portion gets filled the order automatically refreshes to start showing more of the order. The result is it takes a ton of market orders to get through that price. It’s not uncommon to see icebergs of 5,000 to 10,000 lots in the 10 year.
Now the cool thing about an iceberg is that you can sneak in your own order and join the iceberg. When the order refreshes those new lots will be behind you. So you get a spot where the queue is small for more likely fills, but the iceberg means it will require more volume than usual for price to tick through you. So it can be a great place for a limit order, especially as an exit on a small scalp. Be careful about assuming the iceberg will hold though. Icebergs are often hedges or trades that aren’t driven by informed trading. The trader placing the iceberg wouldn’t put it there if they didn’t have reason to think they could get filled. So there’s still a good chance they get through the iceberg, and there’s often little stop runs when the market orders win. As with catching the edge, seeing this setup doesn’t necessarily mean some increased probability of moving up or down. You’re just playing the queue to get a slightly better entry.
Now these are both setups that I would practice trading on. Here is where again Jigsaw is so great because it has a much better simulator than other trading apps. It simulates queue positions correctly, and is actually a little more stingy on fills than real trades would be. So try trading a session on sim where you try to catch the edge as many times as possible, or try joining icebergs. You could even watch for icebergs and try catching the edge when you see an iceberg fail. Give yourself minimal stops are targets that are equal to each other. So when I do this in the 10 year I’m only looking for one tick. Don’t stress too much about the winrate as the goal here is to just get comfortable identifying the situation. With such a short term purely technical trade there’s going to be a lot of randomness to it. You’ll probably get a winrate around 50% depending on how trendy of a day it is. That’s good though because remember random would be more like 45%.
In the next videos we’ll be talking about large orders, and various market conditions. I’ll see you during the morning livestream every day at 8:20 ET. In the meantime stay profitable friends.