Notes for the Powerpoint

Please note the powerpoint is in the post preceding this one: http://trumav1.blogspot.com/2014/01/market-profile-intro-powerpoint.html

Slide 3: 

” The" market, any market; whither it be a car dealership, grocery store, the futures & commodity market, or equity market….. are in existence for one reason, to facilitate trade, to bring buyers & sellers together in the same place at the same time to "do business."

Slide 4:

Bullet #1-The market is always looking for balance. Why? Because when we are in balance the most trade is facilitated, creating hvn's (high volume nodes) & satisfying the sole purpose of the market. If the market is not facilitating enough trade, then it will move either to 1 extreme or the other in the hopes of facilitating the most amount of trade & bring the market back into balance.

Bullet #2- For example, lets take your hometown Starbucks; their selling cups of coffee as fast as they can make them for 2 dollars a piece, good price right? So to increase profits, Starbucks raises the price to 3 bucks, still a good price, and they still sell the coffee as fast as they can make it. The same thing happens at a price of 4 & 5, but now Starbucks starts to get a little greedy, & they raise the price to 9 dollars a cup, not such an attractive price, the customer (the buyer) no longer finds value in a 9 dollar cup of coffee, traffic in the store drops 75%, and where buyers used to lineup to buy, then no longer do. Starbucks (the seller) is forced to drop price back to where the customer found value in their coffee, all the way back down to 5 dollars. The point being that there was no way to know at what price the customer wouldn't find value in the coffee until the price went to high.  Once it was established that 9 dollars a cup was to high, the market for coffee was then able to return to value, & the market balanced at a price where the most amount of trade (or coffee buying & selling) could take place. This is a very basic & crude example, but you get the idea.

Slide 5:

2^nd to Last Bullet- The initiative vs. responsive reaction is one of THE most important thing for any trader to understand & digest to consistently be on the correct side of the market. As traders, especially daytraders such as myself, I want to align myself w/ whoever is being initiative for most trades. The initiative side of the trade is almost always the more aggressive side that also has more conviction, & therefor more likely to move the market.

Last Bullet- Before you can tell the difference, we first need to cover what the value area is & its relationship to the 2 activities.

Slide 6:

B1- VPOC stands for volume point of control, it is the price that has the most volume on any given day, or for whatever timeframe your looking at. The value area is basically where 70% of the volume occurred closest to the VPOC, or almost one standard deviation on either side of the VPOC. 

B2-The VPOC is one of the most important aspects of Market Profile trading. I like to think of VPOC’s as huge gravitron magnets, & the only way price (or value) can move away from these huge magnets w/o getting sucked back in is through above average volume or aggression. The more pronounced the VPOC is, or “fatter” the VPOC is, the more significance it will carry, as that signals a large number of market participants have agreed that price was fair to both sides at that level.

James Dalton says “Perphaps the most important skill you must master to become a successful market profile trader is the ability to distinguish “price” from “value”. This is the real beauty of the profile, as it organizes the information from the entire timeframe spectrum that your looking at in a way that enable you to visualize how value is building & migrating.

How many times have you seen price go out on the high or low of the day, held a trade overnight for that sole reason, then watched it gap the opposite direction just as big. It is imperative to view price in context, value is what is really important, price is just an advertising mechanism that brings the market participants together.

Slide 7

This is just an example of the “gravitron magnet” power that the VPOC has over price. W/o the power aka “big volume or aggression“ price always want to revert back to the mean, or the perceived “fairest price” by both sides so that the market can fulfill its sole purpose. Note the pink line is that days VPOC, & in this example, all week crude oil never had the volume or aggression to move away from these accepted prices.

Slide 8

There are two types of Profile, TPO (Time Price Opportuity)(right image) where each 30 min segment of the market is denoted by a different alphabetical letter. Or the one that I generally prefer, the volume profile (left image). As you can probably already see, the volume profile simply displays the volume that was traded at any given price that day in a histogram fashion. I prefer this method of MP because it doesn't change the shape/form of the profile when the time frame is changed. The data always stays the same across all timeframes. And while time is important, in my own opinion, volume is more important in gauging where the true value lies. A market can sit at price all day, but if no volume is being traded, or “no business is being done” then is that price really being perceived as value???

Slide 9

So this is a monthly profile from 5/1/12-6/14/12……..& I think it shows a nice contrast of HVN’S & LVN’S. HVN’s stand for High Volume Node, they form when both the buyers & sellers agree that price is fair, or in other words the price is accepted at these levels. These are areas where the all important balance is formed, & the most trade is facilitated. The larger the HVN, the more of that “graitron magnet” effect it has on price. Conversely LVN’s, or low volume nodes, are formed when buyers & sellers disagree on price, or in other words reject these prices. Try not to get hung up on why buyers & sellers like or dislike certain prices, because at the end of the day for us, its not really important, what is important is to know where these nodes are & how price generally reacts to them. Im a big golfer so I like to use a golf analogy for how price generally reacts to these nodes. When price hits an HVN, its generally like a golf ball hitting the rough, or really thick grass, price generally slows in these areas because both sides agree (or have agreed in the past) that these prices were fair & obviously if lots of trade is going to be facilitated at these levels, then that takes time. LVN’s on the other hand are like a golf ball hitting something hard like the cart path or a tree, one of two things usually happen, (both a form of price rejection) the market will either blow through the LVN & keep going, kind of like a low hard hit ball skidding off the cart path, or price will reject the LVN & bounce right back in the direction it came from, like a golf ball hitting the front of a tree & bouncing straight backwards. LVN’s are where I personally like to trade, these are usually major inflection points that the market generally respects.

Slide 10

So what are the 2 ways the big boys, or as us Market Profile traders refer to them as “OTF” Other Time Frame….basically the guys that are entering a trade that is not a day trade & are entering a trade w/ size to move the market, how do they move the market? One way is through range extension, the other way is through tails. These are sometimes one in the same, but we will get to that later. Range extension is exactly what it sounds like, extending the range or making new highs/lows. Range extension is just a structural feature that id’s control & helps gauge buyer/seller strength. The stronger the control, the more frequent & elongated the range extension. During a trend day this is very clear OTF dominance that is clearly evident through continued range extension & price movement throughout the day. Tails on the other hand are created when an aggressive buyer or seller enters the market on an extreme & quickly moves prices. Usually the longer the tail, the greater the conviction behind the move. In the above example as you can see on the last day, the tail at the upper extreme of the days profile indicated a strong OTF seller that entered the market & drove price back down. No tails are also significant, the absence of aggressive OTF action on an extreme indicates a lack of buyer or seller conviction & usually doesn’t hold.

Slide 11

Understanding what & where the initiative side is doing is not only important in the day timeframe, but even more important for the swing traders. The market participants are always telling you a story about where they want & expect the market to go. The way you read & understand that story of who is willing to hit the bid, or the offer, or who really thinks that this price is way to low or way to high so they have to get in right now! (just like the 1 dollar coffee buyers at starbucks)

Slide 12

Slide 13

There are 6, (really 7) day types, Normal, Normal Variation, Neutral (Center or Extreme), Trend, Double Distribution Trend, Non-Trend. Starting w/ the Normal day, these really aren’t that normal as they don’t occur very often, (like 5% of the time last time I checked for the ES). Basically Normal Days are when OTF steps in early, forms a wide IB, & at the end of the day, the IB wines up being the high & low of the day. IB stands for Initial Balance (the range of the 1^st hour of trading). These days are usually caused by an early economic release creating the wide IB, then balance ensues the rest of the day w/ little directional conviction.

-So this is a one hour chart of the ES on 1/28/13…..as you can see it never traded outside of the 1^st hours range, making it a normal day. I’ve marked the 1^st hours range w/ red horizontal lines

Slide 14

-A normal variation day is basically when we only break one IB (1^st hours trading range) during the trading day. The OTF conviction is more evident then on a Normal Day due to the range extension on this type of day. Generally balance is still the name of the game on these days.

Slide 15

There are 2 kinds of trend days, a normal trend day, & the double distribution trend day. The most important feature of a standard trend day is the high level of direction confidence & conviction that is evident throughout the day. The OTF buyer or seller remains in control of the auction process almost from the days open to it close. A trend days profile is generally thinner & more elongated as value is never really established.

Slide 16

This is the 2^nd type of trend day, usually these will look like there just gonna be a normal variation day to start out w/ during the 1^st half of the trading day. The way these usually form is when some news hits in the middle of the day, or an economic release like a FED meeting. These are very easy to see in hindsight, as you can clearly see the 2 separate balance areas on the profile, but are not so easy to see in the heat of the moment. In my experience the key is to see the single prints that are formed when it breaks from the initial balance area, & as long as those hold throughout the day, you should assume a DD trend day is in play.

Slide 17

-When a neutral day occurs, it means that the OTF buyer & seller are not far apart in their view of value. The market balances auctioning back & forth between them, probing above/below both the IB high & low during the course of the day. There are two types of neutral day, neutral center & neutral extreme, on a neutral center day (pictured above) the day close w/ price in the middle of the range, indicating a lack of confidence & a balance between the OFT buyer & seller. On a neutral extreme day, price closes on either the high of low extreme of the day, indicating a hypothetical “victory” in the day timeframe battle for control.

Slide 18

A non-trend day is generally just days before/after holidays or days when trading hours are shortened. I generally just act like these day never happened as they do not carry any real significance.

Slide 19

The opening drive is opening type that as traders we pray to see everyday. It is the strongest & most definitive type of open. An opening drive is generally caused by the OTF who have made their market decisions before the opening bell. The market opens & drives in one direction w/o looking back or trading back through the open once the opening range is formed, in what I can the “perfect opening drive” the open is the low or high of the day. Generally we should expect a trend day or wide normal variation day to accompany this opening type. When there is the most potential w/ this type of open, it also offers the most risk to a trader that doesn’t recognize the opening type. I have very few hard & fast rules, but I always say, RULE #1 NEVER FADE AN OPENING DRIVE UNLESS IT PROVES IT TO YOU! The open is marked by the red arrow on the left.

Slide 20

The open test drive is my 2^nd favorite opening type as it is fairly easy to recognize & offers a good risk/reward setup most of the time. It is similar to an opening drive except that the market lacks the initial confidence necessary to drive immediately after the opening bell. Usually the market opens & tests beyond a known reference point, like the prev days high/low or bracket high/low to make sure there is no new business to be done in that direction. The market then reverse & auctions quickly back through the open. The “failed” initial probe will also usually more one of the days extremes. The above example is from AMZN the day after there last earnings report, it was just a textbook open-test drive. The red horizontal line marks the previous days low in AMZN.

Slide 21

The open rejection reverse is when a market opens, trades in one direction, meets opposite activity strong enough to reverse price & return it back through the opening range. We establish the initial extreme when buying or selling in one direction dies out, the auction stalls, & the opposite activity begins to auction price in the other direction. This opening type has less conviction then the previous two opening types meaning that the odds of a trend day are low & we should probably expect a normal variation or neutral day.  Green line is the open, red line is the IB high, yellow line is the prev days high

Slide 22

The dreaded open auction open is an open w/ no apparent conviction at all trading back & forth through the open & opening range. Usually this suggest that no OTF is present & patience is in order to make any trade at all. These openings general produce normal or neutral days.