This is a book on Market Profile, written by James Dalton, Robert Bevan Dalton, and Eric T. Jones.
This is the first book on Market Profile that I have read. I suspect that I would benefit more if I had read one of the introductory Market Profile books before tackling this one. While this book has a short introduction on Market Profile, it does not go into detail, which probably turned out to be a blessing in disguise because it goes more into the other aspects of trading which I find more interesting.
I got interested in learning about Market Profile because a widely featured and followed trader – FuturesTrader71 – was using it. There is also a whole set of tools built around the Market Profile concept, education materials from CME, and a whole set of vocabulary and interpretation “rules” on reading Market Profile. With so much activity and effort spent around Market Profile, it was definitely something that I should look into.
After reading the book, I find that my current ways to read supply/demand works better for me than Market Profile. I have a view that you should reorganize the raw data to show it in a way that makes it the easiest for you to absorb and “see” what you want to uncover. The Market Profile way may work well for other people but I prefer to stick to my tape reading ways.
Nonetheless, the whole crux of Market Profile is to uncover the progress of the market auction process, which is essentially the same as interpreting demand and supply, hence much of the concepts and interpretations are applicable. The discussions in the book help to reinforce and validate what I have already been applying in my own trading, so that’s good.
I just want to quickly jot down my thoughts on some objections that came into my mind when I was reading through the book.
Market Profile uses the number of TPOs (see definition below) to gauge the approximate volume done at a particular price level. I find that really odd because actual volume is readily available and I prefer using actual accurate data over an approximation any day.
One concept of Market Profile is that a prominent price level with a wide width (i.e. long line of TPOs signifying large approximate volume) “attracts” prices, hence there will be above average odds of the prominent price level being revisited. I feel that it may not always be the case. It really depends on what causes the large volume at a certain price level. If there is a huge amount of absorption of supply at a certain price level, followed by price being driven convincingly upwards, that price level where selling was stopped in its tracks would have very low odds of being revisited again. If however there is a price band where there is significant fighting, and price broke out in a non-convincing manner, then yes, I would agree that the same fighting ground would likely to be revisited again.
I was not exactly comfortable with the discussions on different timeframes (i.e. essentially market participants with different timeframes). There was discussion about identifying when the price movements would bring about participation from the longer timeframe compared to the day timeframe. To me, the longer term trend, if clear, is always present, and should always be taken into account, rather than being treated as a separate item and adding a separate layer of complexity to identify when the longer timeframe is coming into play.
My objections aside, I think Market Profile would nonetheless provide an edge to trading, and if coupled with good money management, would constitute a profitable trading system. I am sure there are many very successful traders using Market Profile every day.
As usual, my key learnings are captured below.
- Y-axis is the price, so each row represents a different price level.
- Each time interval is represented by a letter (e.g. each 30-min interval in a day is represented by a different letter).
- As price moves up and down in the day, for each time interval, write down the letter corresponding to that time interval, in the rows corresponding to the prices that the stock has moved through.
- It is assumed the row with the most number of letters is the price with the greatest volume (in market profile, time x price = volume). The actual traded volume is ignored.
- Price is simply an advertising mechanism.
- Time-price opportunities or TPOs are the letters that represent different time intervals (e.g. 30-min intervals on a day-timeframe)
- Value areais defined as the range of prices that includes 70% of all TPOs in a profile — the prices that saw the most activity, as witnessed by the greatest accumulation of individual time-period letters.
- Start with the price that saw the most volume
- Compare the sum of the volume occurring at the two prices directly above the high-volume price, and the sum of the volume occurring at the two prices directly below the high-volume price.
- Include the two prices with the higher sum into the value area.
- Repeat the process.
Fair Value in a Particular Time Period Is the Price Which Results in the Greatest Volume
- The volume, or bidding activity, determines whether or not divergences from value can be sustained.
- On one day, sellers are discouraged by prices below value, and buyers are discouraged by prices above value. When both sides have essentially established a “value area”, any movement away from value will serve to shut off the flow of auction activity until price returns to equilibrium.
A Bracketed Market Shows Low Volume at Extremes, or Actions Reinforcing the Bracket
- If an auction that pushes toward the upper extreme of a bracket occurs on heavy volume, the odds are high that the bracket will not be able to contain the upward movement.
- Conversely, if low volume accompanies an auction at a bracket’s upper extreme, then it is likely that higher prices are effectively cutting off activity; higher prices are not being accepted as “fair”, the bracket’s extremes are affirmed.
- If price is to remain contained within a bracket, we expect to see responsive action: participants “responding” to the advertised opportunity to sell at the upper end of the bracket, …, and to buy at the lower end.
A Transition from a Bracketed Market to a Trending Market Comes with Increasing Volume
- When a market is about to transition from a bracket to a bull trend, higher prices generate more upward volume, leading to an upside breakout.
- Trending markets, in their early stages, demonstrate a high degree of confidence that the current price is unfair. News releases contrary to the existing trend are likely to cause only temporary setbacks while releases that support the trend generally serve to accelerate its progress.
- If higher prices are causing investors to become more aggressive, then logic says that the auction is likely to continue, perhaps even accelerate.
A Trend Goes Through Trending and Balancing Repeatedly But Gradually Ages
- A strong, upward trending market will trend upward, balance, resume its trend, balance, and repeat.
- The stronger the trend, the greater the distance between successive balance areas.
- If we determine that the market is trending, the next step is to determine if the trend is young, ageing, or old.
- As the auction ages, this distance decreases. In the late stages of the trend, price may continue to rise but the next balance area will often be resting on top of or within the prior, lower balancing area.
- The balancing areas serve to allow long-term inventory to come into balance and shake out weak holders/sellers.
Turning Points of a Trend Are Either Accompanied by Volume Drying Up, or Rejection in the Opposite Direction
- Type #1: Volume in the direction of the trend, dries up, no one is left to move the price in the direction of the trend.
- Type #2: Market makes a dramatic price move in the direction of the trend, on low volume, and is quickly rejected by people reacting aggressively in the opposite direction.
- The high volume that is seen at turning points is usually ascribed by most people to capitulation (e.g. high volume in the final moments of a bear market is ascribed to selling activity), but that is incorrect. That volume is actually a result of the action in the other direction, i.e. buyers aggressively rejecting the price moving further down.
- An auction usually isn’t over until we see one last upward spike that draws in the remaining buyers.
Failed Breakouts Tend to Test the Previous Support Level
- When an auction attempt fails to establish value in one direction, and price re-enters a previously accepted value range, the odds are good that the market will auction down and explore the opposite end of the accepted range.
- When stops are taken out and the activity in the direction of the bracket’s boundary simply dries up, then you can be relatively sure that the move was caused by day traders pushing price just high enough to take out the stops placed there. This is a good opportunity to fade, as the market will likely reverse and plunge back into the bracket.
- If, on the other hand, the stops are taken out and the market settles there for a while, the odds are good that a balance-area breakout has occurred, which requires that you place a trade with the breakout.
A Directionless Market will be Focused on Short-term Themes
- When markets lack conviction of a long-term move, they will attach themselves to short-term themes (e.g. Fed rate hikes, seasonal rallies).
- When markets have intermediate to longer-term conviction (e.g. a real rally from the bottom of a major crash), the market will roll right over these short-term themes if they are counter to the directional auction, and will accelerate if they are facing the same direction.
Successful Investing is a Search for Asymmetric Opportunities
- We are always in search of asymmetric opportunities — which simply means that the odds of success are greater than 50%, and that the potential win would be greater than the potential loss.
Three Trading Opportunities Around Intermediate-Term Brackets
- Breakouts from balance
- Go with any directional move (i.e. breakout or breakdown) following an inside day (day’s range is entirely contained within the previous day’s range).
- An inside day is also a neutral or balancing day.
- Monitor closely for continuation after breakout.
- Fading bracket extremes
- Fade the bracket if the price “hangs” at one of the extremes, i.e. price movements slows down and you start to have days with overlapping ranges, and volume decreases.
- Bracket breakouts
- Go with the breakout from an intermediate-term bracket.
Breakouts With the Longer-term Auction is More Significant
- Breakouts in the direction of the longer-term trend is more significant than moves going against the longer-term trend.
A “b-Shaped Pattern” Signifies Long Liquidation and Longer-term Buying
- Sellers are primarily liquidating long positions, rather than a combination of long liquidation and new shorting.
- When there is the formation of new shorting that is consistent, the market profile will become elongated (not bell-shaped but long vertical market profile).
- Buyers are at least slightly more patient than sellers, they are not in it for a “day trade”, but rather some longer timeframe — at least overnight. [My note: Day trade buyers would be selling, not buying. Those buyers absorbing the supply must be in it for a longer term, at least longer than that day.]
A “p-Shaped Pattern” Signifies a Short Covering Rally and Longer-term Selling
- When there is a short covering rally, but a lack of continued new buying, the profile shape resembles the letter p.
- All rallies, at least initially, include a combination of short covering and new buying. For the rally to be sustained, new buying must overtake short covering.
- The short covering is met by new sellers who are selling for a longer timeframe.
Those Who Get In Late are the First to Exit
- Those who get in late in the game are weak money and unlikely to have staying power.
An Elongated Trend Day Suggests Continuation
- A trending day in the direction of the major trend, suggests continuation of the major trend.
- The day may start with a gap in the direction of the day’s trend.
- The market may accelerate late in the afternoon and close near the low.
- There should be decent volume accompanying the day.
- Such a trend day will have an elongated market profile (not a bell-shaped normal distribution but just a long vertical market profile).
Unwinding of Flight-To-Safety Trades Brings About Asymmetric Opportunities
- Usually the market has rallied far above value (e.g. U.S. treasuries). Once the unwinding begins, the market is likely to return quickly to, and potentially pass through those areas where price movements weren’t supported by healthy volume.
Four Types of Open
- Market opens and auctions aggressively in one direction.
- Market opens and tests beyond a known reference point — such as a previous high or low — to make sure there is no business to be done in that direction.
- The market then reverses and quickly auctions back through the opening, i.e. a failed test in one direction followed by a strong reversal.
- Market opens, trades in one direction, meets strong opposite activity which reverses the auction and drives it back through the opening range.
- Market opens and appears to randomly auction above and below the opening range.
- An Open-Auction that occurs inside the previous day’s range usually develops into a day with no convictions.
- An Open-Auction that occurs outside of the previous day’s range usually results in a dramatic move in either direction.
- If the market quickly returns to the previous day’s value area, the odds are good that the market will continue on to the opposite extreme of the previous day’s range (i.e. opening rejected)
- Failure to return to yesterday’s range increases the odds of a meaningful, directional move in the direction of the out-of-balance opening.