Rajandran R Founder of Marketcalls and Co-Founder Algomojo. Full-Time Derivative Trader. Expert in Designing Trading Systems (Amibroker, Ninjatrader, Metatrader, Python, Pinescript). Trading the markets since 2006. Mentoring Traders on Trading System Designing, Market Profile, Orderflow and Trade Automation.

How to Determine the Options Liquidity using Orderflow?

2 min read

For Starters, Orderflow is used to visualize the active buyers and sellers behavior in real-time. Not many people will not know that Orderflow can also be used to indirectly measure the liquidity of any trading instrument.

What is Liquidity?

Liquidity generally refers to the ease with which an asset can be exchanged for cash without affecting the price of that asset. If in case one needs to exit the trades immediately then one has to place market orders which results in buying/selling from the best available price (Bid x Ask Price). Market orders are filled immediately based on the Pending Orders available in the orderbook.

How Liquidity Can be Measured?

Liquidity can be measured in various ways

1)Bid-Ask Spread : Tighter the Best Bid-Ask Price spread throughout the day higher the trading participation and more liquidity flow is available. However wide the Bid-Ask spread lesser the trading participation and less liquidity flow is available.

2)OrderBook Depth: It refers to the total number of pending limit orders available on the orderbook. Larger the depth bigger the liquidity.

3)Open Interest: Measuring the open interest shows how much open contracts are available and the higher the number the larger the interest from the trading community and the higher the liquidity. Lower the numbers lower the trading interest and may be difficult to exit such trading positions.

4)Trading Volume: Apart from open interest one can use Trading volume to determine the trading interest. High liquid counter often results in higher volume and thats the concept used in orderflow as well to measure the liquidity via executed trades.

5)Bookmap: Bookmap is an order flow visualization tool to visualize real-time liquidity to understand the anatomy of pending orders. Requires level 3 data to do orderbook visualization by creating a synthetic orderbook.

What is OrderBook?

Orderbook is a ledger maintained by the exchange to match the market orders with pending limit orders. Orderbook shows only the pending limit orders (Passive Orders) and does not show any active orders (Market Orders). Most of the Brokers do provide up to Top 5 levels of Best BidxAsk Price and the trade size Brokers like Zerodha provide up to the top 20 levels. And High-frequency traders using TBT feeds (tick by tick feeds) get access to the complete depth of the market (all the pending orders at all the order sizes)

What is Orderflow?

Orderflow is a visual tool to understand the flow of Market Orders (Executed Transactions). It displays the Executed Buy market order and sells market order.

Orderflow – 4 strike wide Nifty ITM Weekly Options (05th Aug 2021 15500CE Contract) with Moderate Liquidity

Orderflow helps traders indirectly measure the presense of liquidity throughout the day. Orderflow shows executed transactions. so high volume transactions are generally a result of trade execution happening around liquidity and lower volume transactions are generally a result of lower liquidity.

The above tool shows the visualization of Buyers and Sellers at each and every price level. Buyers on the right-hand side and sellers on the left-hand side. It is a lot easier to measure liquid scrips

From the orderflow charts one can look into the rate of fill in realtime to measure the liquidity. Higher the rate of fill, higher the liquidity and so denser the orderflow volumes. However lower the rate of fill , lower the liquidity and so less dense the orderflow volumes.

Orderflow – Nifty ATM Weekly Options (05th Aug 2021 15800CE Contract) with Huge Liquidity

Orderflow – 2strike wide Nifty OTM Weekly Options (05th Aug 2021 16000CE Contract) with Huge Liquidity

Why measuring liquidity is important?

1)It helps system traders to determine the slippages during high volatile and low volatile times. It is particularly helpful for automated traders who would like to send market orders to the exchange.

2)Measuring the liquidity and understanding the depth is a much-required factor if you are a trader who handles large trade sizes. Failure to study liquidity before indulging in punching big orders could result in serious impact and slippage cost.

3)If you are trading in illiquid counters unknowing one could end up paying more cost than the actual and in some illiquid stock even there could be a risk of manipulation could be a possibility.

A good trader study about the trading cost, slippage cost, impact cost, and a simple transaction cost analysis could save a lot of time in avoiding bad trade execution practices.

Rajandran R Founder of Marketcalls and Co-Founder Algomojo. Full-Time Derivative Trader. Expert in Designing Trading Systems (Amibroker, Ninjatrader, Metatrader, Python, Pinescript). Trading the markets since 2006. Mentoring Traders on Trading System Designing, Market Profile, Orderflow and Trade Automation.

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