October 25, 2021
Live Options Flow is a pivotal tool for all kinds of traders. Be it a day trader, swing trader, or a long term investor, options flow can provide insights that can help traders find an edge in the markets. However, understanding options flow can be tricky since it is used for a wide variety of purposes such as directional bets, hedging, multi-legged strategies, etc. Therefore, in this guide, we are going to talk about an innovating algorithm & tool called Tradytics AlgoFlow that looks at options flow from a new lens and makes it easy for retail traders to find options traders' sentiment in a visual and easy-to-use way and get ahead of others in the market.
In simple terms, AlgoFlow is an aggregated and cumulative representation of options flow at every minute of the day. In even simpler terms, AlgoFlow illustrates the sentiment of market participants at all times. Instead of retail traders having to manually go through options flow to find their plays, which can be cumbersome, AlgoFlow shows a simple visual representation of the flow sentiment and makes it easy to identify patterns that can help traders find effective plays.
The image above provides a good illustration of how AlgoFlow works. At every minute of the day, we iterate over the live options flow of a stock, apply proprietary filtering, and aggregate the data to form a score. That score is called AlgoScore and is a single point on the chart shown above. We repeat this for every minute, and show a cumulative value of AlgoScore on the chart, which we simply call AlgoFlow. Finally, we also plot the underlying stock price along with the AlgoFlow to demonstrates the sentiment of the options flow traders compared to the movement in the stock price.
When AlgoFlow is in an uptrend, that signifies that options traders are bullish on the stock and are expecting the price to go up. In contrast, when algo is colored red, or is in a downtrend, that shows a bearish sentiment from options traders, which can result in the stock price going down. This is important to understand because the understanding of bullish vs bearish AlgoFlow is used to create and play divergences, which we will talk about in a minute.
The figure above shows a visual difference between a bullish and bearish AlgoFlow. On the left side, we have the AlgoFlow line going up in a nice uptrend, which is why it is also colored green. On the right side, the AlgoFlow is going down while the stock price remains choppy. Now that we have a good understanding of what AlgoFlow is and what's the difference between bullish and bearish AlgoFlow, we can talk about divergences, which is the most important aspect of the AlgoFlow for finding plays.
A divergence is an instance where algo flow is going in a completely opposite direction to the stock price.
When we are looking at AlgoFlow, we want to find stocks that have a divergence with the AlgoFlow. For a bullish divergence, the stock has to be going down or consolidating while the AlgoFlow keeps going up. Why do we care about divergence? Remember again that AlgoFlow shows you the sentiment of options traders. If it is going up while the stock is going down or consolidating, options traders are expecting the price to reverse or continue going up after the consolidation. Similarly, a bearish divergence is when the AlgoFlow is going down while the stock is going up or consolidating. That can signify that options traders are expecting the stock to come down soon.
We can see above that on the bullish divergence, stock keeps going down while the AlgoFlow keeps going up indicating that options traders are expecting a reversal soon. On the bearish divergence, as the price goes up, AlgoFlow goes down which tells us that options traders have a bearish point of view right now for the stock.
Being equipped with the knowledge of AlgoFlow divergences, we can now talk about how to play them. There are a few rough rules that you can follow in order to play them.
The first thing we need to make sure is that the divergence is large i.e there is a large distance between the stock price and the AlgoFlow on the chart. That gives us more room and profit potential since price will have to make a big move to converge to the AlgoFlow.
You can draw AlgoFlow for various time frames on our Options Dashboard. For instance, 1 Minute AlgoFlow gives you a full day of data. To get longer periods of data, you can use 5 Min AlgoFlow, 15 Min AlgoFlow and 30 Min AlgoFlow, which will give you about 5, 15, and 30 days of historical stock vs AlgoFlow respectively. When going into a play, please make sure that the divergence exists on multiple timeframes, especially on the 1 Min and 5 Min charts. That significantly improves the performance of the plays. Shorter term timeframes are used for scalping or daytrading while longer timeframes are used for swing trading or investing.
Although AlgoFlow alone can give great results, it is always great to add some additional due diligence to improve the probability of your plays. For instance, you can use technical analysis such as support and resistance levels to find precise entries for your plays and let the stock converge towards the AlgoFlow after you enter.
When working with any data analysis based tool, it is always a good idea to make sure you have as many confluence factors as you possibly can. The more factors we have going in our favor, the better the odds that our play will work well. Trading is inherently difficult and adding more factors in our favor always helps, no matter the tool you are using.
As discussed above, different timeframes serve different types of traders. A rough categorization is as follows. 1 Min AlgoFlow gives 1 Day's data, which is why it should only be used by Scalpers and Intraday Traders. 5 Min AlgoFlow shows about 5 Days of Data - it should be used for short term Swing Traders. 15 and 30 Min AlgoFlows should be used for slightly longer term Swing Traders. 30 Minutes should only be used for 3-6 months of investing period.
Theory is good but is futile without practical examples, so let's talk about one. This is a trade from October 25th, 2021 when $TSLA crossed $1k in price, and 1 trillion in marketcap. The price started to move up right when the market opened. After the initial move, it started to consolidate, but AlgoFlow kept going up creating a good sized bullish divergence. The divergence was visible on both 1 Min and 5 Min AlgoFlow charts. After some consolidation, the stock broke out, which was our entry. This is where a little bit of technical analysis helps. Entry signals like breakouts from resistance, reversals from support, oversold and overbought levels on technical indicators, moving averages, etc. are useful for finding entries. Once we enter, we wait for the divergence to get filled, which we call a convergence. As soon as we converge, we can either exit partially and let some shares/options run or we can exit completely.
This is where a little bit of technical analysis helps. Entry signals like breakouts from resistance, reversals from support, oversold and overbought levels on technical indicators, moving averages, etc. are useful for finding entries.
Traders usually complain that platforms post content after it has panned out. Therefore, this case study has actually not worked out yet. We at Tradytics found this play today. A few days ago, $FB gapped down. When we opened the next day, price continued moving sideways and down but the AlgoFlow immediately started an uptrend thus letting us know that options traders are expecting a reversal back. The divergence is most clear on the 5 Min (3-5 Days of Data) and 15 Min (10-15 Days of Data) AlgoFlow charts, which is what we are showing above. Our entry is either today right on the market close, or tomorrow if we continue the gap fill. Our exit would be the convergence point which is around 340.
It is to be noted that $FB had earnings at the date of this post, and it did shoot up a bit after hours, which means a small move has already been made. However, there's still some distance left in order to reach 340, which is what we will target. We will come back to this paragraph, and update whether the play worked or not. UPDATE from November 8th - price gapped down after earnings, but has fully recovered and is now above 340. This is why it is always a good idea to have some extra time in your Trady flow plays.
AlgoFlow is like a swiss army knife for Tradytics users. Once you spend some time using it, you will be able to figure out tons of patterns to help you find different plays.
AlgoFlow is like a swiss army knife for Tradytics users. It doesn't just provide divergence plays, but also trend following and continuation plays. Once you spend some time using it, you will be able to figure out tons of patterns to help you find plays. But in this section, we will shortly talk about continuation plays.
Since we know AlgoFlow shows the sentiment of options traders, we can also use it to find continuation plays. In contrast to a divergence, if the AlgoFlow and Stock Price goes in the same direction in a strong trend, that signifies that options traders are expecting the price to continue moving in the same trend, until a divergence emerges. Therefore, we can use this information to continue staying in our plays, or go into new plays.
In contrast to a divergence, if the AlgoFlow and Stock Price goes in the same direction in a strong trend, that signifies that options traders are expecting the price to continue moving in the same trend until a divergence emerges.
An example of continuation plays is attached above. $AMD has been going up for a week or two at the time of writing this post. We can see that the 5 Min AlgoFlow here also keeps following the price. Anytime there is a small divergence, it gets converged immediately and the overall trend remains the same. This is a great example of staying in a play if you're already in, or expecting the price to continue and buying calls or shares.
Finally, we want to talk about some limitations of AlgoFlow and give some final thoughts. Since AlgoFlow is solely based on options flow data, it has inherently all the limitations that flow data has. For instance, on many occasions, flow data is being used for hedging purposes. We do our best to filter for such scenarios but it is impossible to completely remove it since we are not fully aware of the intentions of options traders making the trades. Sometimes, individual trades are also parts of multi-legged options strategies, which can seep through in the flow data. Again, we have comprehensive filtering to remove data like this but some of it still can remain in there and add some noise in the AlgoFlow.
Since AlgoFlow is solely based on options flow data, it has inherently all the limitations that flow data has.
All in all, as long as you are aware of the limitations, and do some due diligence before going into a play, you will be fine. AlgoFlow has completely revolutionized how our users at Tradytics use options flow data. Instead of spending large amounts of their time looking at individual options flow trades, they simply start with AlgoFlow to get a micro and macro sentiment of options traders, before diving further into more granular data.
We hope this guide will prove useful for you. We are always working towards giving retail traders an edge in the market, and AlgoFlow is an effort towards that. If you like it, you can give our entire platform a try at Tradytics.
Trading is hard. Let Tradytics help you find your edge.