There are lots of tools available to us traders; some good, some bad, some you need to stay well away from (like indicators).
But there’s one tool not many people know about that provides some amazing insights:
Tucked away in the far reaches of Oanda’s website, the order book is a tool that shows information on the open positions and orders of all the traders and investors using Oanda.
Understanding how people make decisions is one of the keys to becoming a successful trader, and it’s one the order book can provide you with a lot of insight on.
In today’s post, I’m going to show you the 3 biggest insights I’ve learned from studying the order book and explain how you can use them in your trading.
Insight #1 Most People Place Their Stops At Big Round Numbers
Common knowledge tells us that most traders place their stops at swing lows/highs or at points relevant to their trading strategy.
At least, that’s what all the books, videos and gurus teach us.
But one of the most obvious insights gleaned from order book is that traders don’t place their stops at the points mentioned above, they place them at big round numbers – numbers that end in 00, 000 or 0000.
This might seem rather strange, but it’s actually far more common than you think…
In 2006 using data from a German Forex broker, researches found that stop and general limit orders build up around big round number levels on the GDX 100 – the German stock index.
In 2011 researchers noticed that limit orders (including stops) build up at big round number levels on the commodities exchanges.
You might be wondering why people do this. And the honest answer is no-one knows….for sure at least.
The main theory is something called “prominent number theory” which says that people naturally gravitate towards placing their orders at round number simply because it’s easier for them to remember. But there’s another that states it’s because people just generally have a fondness for round numbers.
Whatever the reason, it’s pretty interesting.
So, stop orders being placed at round number levels isn’t actually that uncommon, but how can this help you in your trading?
Let’s find out…
Lots Of Stops = High Chance Of Reversal
See the reversals above…
Notice they both began almost EXACTLY when the price hit 1.12500 – the big round number.
Know why it reversed here?
Because the price hit a HUGE number of stops that had accumulated around 1.12500.
Most traders forget or don’t know perhaps that a stop loss order, once hit, converts into a limit order to buy or sell (buy in this case).
Because of this, when the price hits a big bunch of stop orders, it often reverses.
See where I’m going with this?
So if you use the order book to locate where a large number of stops have built up, you can spot where the price may reverse, and then get your own trade placed to take advantage.
Insight #2 People Love Holding Losing Trades Open
What’s that piece of advice you hear repeated time and time again in Forex?
“Never hold a losing trades open”.
Simple advice? Sure. Easy to follow? Not if the order book is anything to go by.
Take a look at the bars marked above.
See how big they are, and how far away from the current price they are?
Well, get this…
These bars show traders trapped in losing trades.
Yes, there’s THAT many.
In my opinion, this is one of the most eye-opening insights the order book gives.
I don’t know about you, but I always believed this is something most traders don’t do. I mean, it’s the only thing you ever hear from all the books, gurus and video…
Everyone says it repeatedly and yet most traders still can’t do it.
Guess we’re the smart ones after all.
People Have To Close… At Some Point
There’s a small bar at the bottom of the graph in the previous image that shows people are trapped in losing trades from 13.256 – 500 points below the current price.
Can you imagine that, being at a 500 point loss!
The thing to understand about traders holding losers is they cannot hold forever; at some point, they MUST CLOSE.
Now I’m not sure how many of you know this, but to close a trade, whether it’s at a loss or profit, you have to use the opposite type of order:
To close a buy trade, you must sell.
To close a sell trade, you must buy.
When people buy or sell it causes the price to move (obviously). So what do you think happens when lots of traders unwittingly buy or sell via closing their losing trades…
The price moves… A LOT.
The order book, because shows where everyone is trapped, lets you gauge when people are likely to close, which means you can use it to anticipate when the price is likely to move.
Traders close trades all the time, but it usually takes a significant event (like a news release) or sharp rise or drop to make them close en-mass.
So if you see a large percentage are trapped far away from the current price and then a see a sharp movement, you can guarantee that rise or drop will continue for a while, as most of the trapped traders will be closing their losing trades.
Insight #3 Traders Buy And Sell Impulsively
We’ve all done it…
The price takes off and looks like it’s heading towards the moon, so you instantly buy to not to miss out on all the profit.
….then it reverses, and you end up losing.
Buying and selling because the price ‘looks’ like it’s going to continue rising/falling is a HUGE problem in forex (and probably other markets too), and it’s one the order book confirms is way bigger than expected.
Look at the open positions graph and keep a mental note of how big the bars are.
Now, look at them after a sharp rise…
See how BIG they become?
This shows that when the price dropped thousands and thousands of traders piled in short because they thought the price was certain to keep falling.
And what happened shortly after?
Price retraced and (probably) caused most of them to lose money.
Sucks to be them, huh?
So, how can knowing most people impulsively buy and sell help you when trading?
Let’s take a look…
After A Sharp Movement, Expect To See A Small Retracement
Have you ever seen a sharp movement – a movement where the price rises or falls a huge distance in one or two candlesticks?
Of course, you have, they’re everywhere.
But did you know that a retracement will almost always take place immediately after they form?
Yes, here’s why…
A sharp movement is created as a result of banks buying (or selling, in the case of sharp declines) a huge amount of currency.
After they buy (or sell) the first thing the banks want to do is take some profits off – just like we would.
The problem is they CANNOT take profits unless lots of people are doing the opposite; buying if they want to sell and selling if they want to buy.
Are you with me?
Now, most traders impulsively buy or sell when they see a sharp rise or drop take place.
We know this from looking at the order book.
The important thing to understand is that these traders are the ones who give the banks the ability to take profits because when they buy (assuming it’s a sharp rise) the banks have people to sell too.
Of course, when the banks decide to take profits the price will fall (or rise, if they sold to sharp decline) and a retracement will take place.
So what does this all mean?
It means if you see a sharp movement and then watch the order book, when you see that lots more traders have opened trades in the direction of the movement, you know that a retracement is likely to soon begin, because the banks who caused the rise or decline now have traders who they can use to take their profits.
So you can anticipate when a retracement will take place by looking at how many people have opened trades in the direction of the movement.
If you see that lots have opened via the open positions graph becoming very one-sided i.e by seeing that lots of traders have open trades close to the current price, you know a retracement may soon begin because the banks now have a group of people who they can use to take their profits off.
Well, there you have it: 3 super useful insights from Oanda’s order book. I hope these insights have given you a better understanding of how people trade and some ideas on how you can use the order book in your own trading.