Imbalance Trading Strategy - Backtest, Live Trading, Statistics, Facts

Imbalance trading strategy, also known as order imbalance trading, is a “technical analysis” approach that utilizes the imbalance between buy and sell orders to identify potential trading opportunities.

This strategy is based on the premise that large imbalances, especially when sustained over time, can indicate the underlying momentum of the market and provide insights into the sentiment of large institutional traders. As such you are working as a small market maker because you are providing liquidity.

Imbalance trading strategy involves observing order flow data, which captures the volume and price levels of buy and sell orders in a financial instrument. By analyzing the distribution of these orders, traders can assess the imbalance and determine whether it suggests a trend reversal or continuation.

The significance of imbalance trading lies in its ability to provide early signals of market direction, potentially offering traders a competitive edge. By identifying large imbalances early, traders can position themselves for potential price movements before the broader market catches on.

In the dynamic world of financial markets, market imbalances arise when the number of buy or sell orders for a particular security deviates significantly from the other. This imbalance disrupts the natural equilibrium of supply and demand, potentially influencing the security’s price.

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Imbalance Trading Strategy – backtest and statistics

We have first hand experience in order imbalance trading. We used this technique for trading stocks at the open for about two decades.

Before we explain the order imbalance trading strategy at the open (and close), you might want to read the takeaways, statistics, and facts from 2002 to 2012: 12 years of real empirical analysis from live trading.

For example, the best month was October 2008, in the midst of the financial crisis, where we made a significant amount of money by only day trading (and mostly from the long side even though the markets were free-falling). We have covered our day trading in a separate article called it possible to make money day trading – a real historical strategy simulation. We consider the article a live backtest of the imbalance trading strategy.

Now, before you get eager to try this out, we have to disappoint you:

First, the strategy is not performing so well anymore. Markets have changed and the big imbalances are not there anymore. Second, it’s not as straightforward as we explained because we had a couple of other variables/twists we put in and which we don’t want to reveal. Sorry.

And, in case you are wondering, we are not trading this strategy anymore and we assume it has been mostly “arbed” away for good (?). But the main principles and takeaways are still valid and can probably be used as inputs for other strategies, or it might give you some ideas.

This is how we played the order imbalance strategy at the open:

We adjusted the closing price of each stock based on the indications of the S&P 500 futures. This is the fair value of the stocks. If the futures indicates an opening 0.5%, the fair value of the stock is also 0.5% up.
Then we placed both a buy and sell order x % below and above the fair value. For example, we placed a buy order 0.5% below the fair value, and a short order 0.5% above the fair value. Pretty simple.
We sent thousands or orders.
When the market opened we got many fills, but most stocks opened without any fills. At busiest days we could end up with as much as 200 different tickers.
We exited partly via profit target and time exit.

In essence, the above sequence is what we did for about two decades, however, as indicated, we had a few twists that we don’t want to reveal. Some stock exchanges are still distributing order imbalances both for the open and the close.

We made about 2 cents on average per trade. That is not much, but it’s all about volume and getting many fills. This is a perfect example of quantitative and automated trading. Sending orders was done by pushing buttons.

You might also find our pretty personal article about confessions of a day trader and how day traders