How To Become A Crypto Flow Trader

Markets are full of seemingly endless strategies and indicators for making money. Some methods are useful, others are downright disastrous. Throughout my own career, I’ve tried every way under the sun to trade. With 99% of these methods, I lose money. 

But a real lightbulb moment happened when a fellow trader talked about trading flows instead of price. What are flows? How do traders analyze them? Basic answers to both of these questions (and more) are explained in this article with the goal of hopefully piquing a reader’s interest in exploring the world of flow trading. 

What are flows? 

For the purposes of this article, when “flows” are mentioned, that term refers to an aggregate of trades grouped by a common origin (the trader) or purpose (the reason why they took the trade). 

Here are some simple examples of flows: 

• Whale Flows: Trades of a notably large notional size, such as over $1m USD. 
• Insider Flows: Trades that occur in a token before an announcement. 
• VC Hedging Flows: Trades from funds looking to hedge locked tokens with futures.

Why trade flows?

Flows that require immediate fills via a market order are the only thing that move price. 

If a trader longed a coin, they want others to come and buy it afterward. If they short a coin, they want others to come and sell it after too. In effect, when a trader is worried about price, what they’re really worried about is flows. (Is this concept starting to click?) 

Trading is really hard. So, wherever possible, it’s best to simplify things. Do this by focusing on the first principles. If price is a result of flows, focus on predicting flows and price should follow thereafter. It can really be that simple. 

How do you trade flows?

First, identify the origins of the flows. 

Traders want to build a mental model for the market they’re trading in part by asking themselves, “Who are all the different participants?” Broadly speaking, they’ll fit into three buckets: 

• Speculators: Trade the market as their primary business. 
• Consumers / Producers: Trade the market to assist in other business. 
• Market Makers / Exchanges: Facilitate trade within the market. 

Next, identify the purpose of the flows. 

Traders should ask themselves, “For what reasons might these participants interact with the market?” Here are a few ideas just to help get started with this thought process with the same three categories referenced above. 

• Speculators: React to news headlines. Purchase undervalued assets. Sell overvalued assets. FOMO into assets. 
• Consumers / Producers: Acquiring raw materials for production. Selling future production to cover immediate costs. Hedging future prices of raw materials. 
• Market Makers / Exchanges: Hedge risk exposures. Provide index products. Create ancillary markets, such as margin borrow and lend.

Last, monitor the impact of order flows. How is a trader able to monitor these flows? Good question. In particular, a trader will want to know three basic things: 

• How active are the individual flows? 
• How much of the overall volume in a specific product, coin or market do they account for? 
• What kind of market impact do they have? 

Context: Example Flow Trading

Considering a specific flow trading example may be helpful to contextualize this.

Many coins offer inflationary single-sided staking with high APRs, some also have liquid perpetual futures listed on popular centralised exchanges. As such, a common trading strategy from speculators is to buy spot tokens, stake these to earn the high staking APR and then short the perpetual futures of the token. 

Doing so, the speculator effectively attempts to earn the staking APR, without taking on the risk of being exposed to the price of the underlying token. This works as long as the costs associated with the perps hedge, both the funding rate and trading fees, do not exceed that of the staking APR. The difference between these costs and the staking APR is their profit.

The trading strategy explained above is an example of a flow impacting a token’s perpetual and spot market. If the perpetuals market is dominated by the above flow, traders would expect most futures positioning to be short, which they can easily check through many online tools, such as Velo, Coinalyze and the exchange’s own website. 

Similarly, traders would expect the perps to trade at a consistent discount to the spot market, with a funding rate that gets closer and closer to the negative of the staking APR, the more this flow dominates the perpetuals market. Using these two metrics, a trader can get an idea for the impact of this flow on the market.

So, if the price of the token dramatically increases, what should trader expect to happen? 

The notional size of speculators positions will have also increased, and thus traders should expect them to rebalance and decrease the size of their position, back to its original notional size. As such, a trader should expect consistent, aggressive buying pressure in the futures book and consistent, aggressive selling pressure in the spot book. 

A trader can choose to take advantage of this in two ways:

1. If there is a wide enough spread, which there won’t always be, they can ride the wave of this rebalancing flow by longing the perp and being short on spot margin.
2. If there isn’t a wide enough spread, they can look to deploy the same trading strategy as the original flow, but using the rebalance flow to do so at cheaper prices than they were able to. 

Traders could track the rebalance flow happening by looking for a decrease in open interest on the perps and comparing that data again using Velo, Coinalyze or the exchange’s website.

What is a good flow trade?

A good flows-based trade will focus on a scenario where most of the flow in a specific coin is doing one thing because of some external reason. If that reason changes, flows will be forced to go in the opposite direction. At this moment, a trader should strike and take a position that will benefit from the change in flows. At its core, that is a good flow trade.