Key Insights on Trading using Market Profile The 4 critical elements of a Trade: 1) Potential Level or trade area: You want a reason why you think this is a level or area where you want to put on a trade. The reason can be related to Key Price Levels (weekly, monthly highs/lows), top/bottom of Balance areas, Big Gap up/down in Price at the Open etc. etc. 2) Entry technique: Once in the area, you then want a trigger that tells you where you want to become involved in the trade, that now is the time!! e.g. Sellers/Buyers are drying up and Volume has declined rapidly or other technical indicators you choose to use. 3) Trade size: You must decide ahead of time what the trade size will be i.e. how many contracts? Why? Because all trades do not offer the same risk/reward opportunities. 4) Trade management: You want to have a plan in place, before you even consider getting in the trade that tells you how you will manage this trade, whether it goes for you or against you. Before entering a trade - it is key to know when you will exit this trade i.e. when will you know that you are "wrong" i.e. Stop Loss level.
As I prepare for the following trading day, I look at the following relative to the previous day: 1. Attempted Direction - which way was the market attempting to go? 2. Volume - associated with the directional move 3. Value Area Placement - Higher to overlapping higher, Unchanged, Lower to overlapping lower 4. Shape - was the Profile elongated, symmetrical or squat - specific patters like "p" shaped or "b" shaped In addition, I always identify 3 references above and below the prior Pit Session Close.
The following is a list of KEY REFERENCES: Previous Day High, Low, Close and Point of Control (POC) 2. Overnight High and Low and determine if the Overnight Inventory is Long or Short 3. Rally High or Pullback Low 4. Bracket/Balance Highs and Lows 5. Spikes - Base and Top/Bottom 6. Gaps 7. Current Session Opening Print and Range 8. Longer Term references from Weekly & Monthly charts. 1.
The Pit Session "Open" 1. The first question to ask yourself as the pit session is approaching is, are we likely to open in or out of balance relative to the center of yesterday’s range. 2. If out of balance relative to the center, are we still within balance relative to the previous day’s range. 3. The closer we are to being tightly within balance, the greater the odds of a rotational day and the smaller the opportunities - The exception is when the market single prints out of range which is usually a sign of high confidence. 4. The further away from the center of yesterday's range the greater the odds for a more directional auction. 5. The more out of balance the market is, the higher the expected volatility and the larger the opportunities. During the course of the day, I monitor and take note of the following: 1. Opening 2. Developing Value Area 3. Volume Analysis 4. Overall Confidence 5. News Annoucements 6. Projected Profile Shape 7. Possible Destinations
Trading Balance Spotting Balance areas or "brackets" is key to finding good trading opportunities as Markets spend almost 80% of the time balancing and the remainder 20% of the time trending up or down. One has to be prepared for 3 possible scenarios when trading Balance 1. Market remains within balance; 2. Look outside of balance and fails; If the market fails on one extreme, the destination trade becomes the opposite extreme. 3. Looks above or below the Balance area and accelerates - which is a breakout from Balance. A strong breakout is more likely to settle on the upper end of the range. Other points of Note: • The longer the balance has existed the better the chances that the breakout will be dynamic e.g. a 3-5 day balance is a long time if you are a short term trader. • Overlapping trading ranges (or Balance areas) are a sign of an aging trend along with low confidence. Additionally, the lack of balance ranges which is the result of short covering, increases the risk to those holding long positions; when there are balancing ranges they act as elevator stops when negative news arrives. Without these elevator stops, linear breaks are more likely. The message from balanced markets is that more information is needed before the market begins its next directional auction. • In all timeframes, markets tend to move from trend to balance; from balance the market reverts to the original trend or begins a new trend in the opposite direction. •
What is "Excess" - in terms of Market Profile - it marks the end of one auction and the beginning of a new auction. It is visible within the two-way auction process via :1. Buying and Selling Tails i.e. a series of single prints at
the day's high or low - the longer the tail - the stronger the excess. Tails should be at least 2-3 tics in length. 2. Gaps - where Price moves rapidly away from a prior trading level or reference; a gap signifies a total reordering in market thinking.
Trading Gaps When Gaps are small - they usually fill quickly and Overnite Inventory has an impact. When we are dealing with a large gap it is not uncommon to require multiple attempts (days) to completely fill the gap; the first attempt is often quickly rejected. This occurs because too many traders have been caught the wrong way. Additionally, it is not uncommon that the odds of a rotational day are rather high following a large gap as the market seeks to assimilate new information and regain balance. Use the following rules to trade Gaps :1. If the Gap is not filled then trade in the direction of the Gap - especially if it is not filled in the first 30 -35 minutes of trading after the Open. 2. If the Gap is filled look for elongation in profile and price to continually auction higher/lower. The next observation is to observe if we can get unchanged Value relative to the previous day's Value Area. 3. If Value does not become unchanged, the odds are the market will turn back in the direction of the Gap either in the middle or late in the day. Always remember - we trade Value not Price. E.g. If we have gapped up - A weak market will experience consistent selling from the opening bell, a closing of the gap, which is then followed by the outside day. At a minimum, value will be unchanged. Other Notes on Gaps: • Back-to-back gaps are unusual in stocks; when double gaps do occur the correction, very often, has a dynamic conclusion with a final rapid rise/drop and break/rebound. • Following a gap, which is usually considered excess, markets mostly sprint higher/lower; the exception is when the gap is an Exhaustion gap. Exhaustion gaps are, unfortunately, only confirmed after the fact. • Gaps are also frequently the precursor of a more significant, directional auction. An Excess High/Low followed by a Gap is the most potent combination for reversal - when observing a multiple day auction. Trading Spikes - A spike is a late day price probe either to the upside or downside during pit session hours. It usually occurs in the last hour of the Pit Session. We are forced to await the market’s opening during the pit session of the following day to verify whether it has been accepted or rejected. If the Spike was on low Volume, then odds favor price reverting back to the mean - which would be the Value Area from the day the Spike occurred. Spike's are also another form of Excess for e.g. if an upside probe was rejected we would be left with a selling tail. Upward Spike
1. A price opening below an upward spike would be considered negative since the price probe or spike was rejected leaving a selling tail. 2. Opening within a spike shows price acceptance and keeps the rally in tact; 3. Opening and trading above an upward spike reveals that price has not auctioned (probed) high enough to cut off the buying allowing for two-sided trade. The auction is not over. 4. The bottom of the spike is “support". Downward Spike 1. A price opening and trading above a downward spike would be considered positive since the price probe or spike was rejected leaving a buying tail. 2. Opening within a spike shows price acceptance and keeps the break intact; 3. Opening and trading below a downward spike reveals that price has not auctioned (probed) low enough to cut off the selling allowing for two-sided trade. The auction is not over. 4. The top of the spike is “resistance”. IMPORTANCE OF POINT OF CONTROL (POC) - This is the longest line of TPOs closest to the center of the daily range. This is the price where the most activity occurred during the day (based upon time); it is therefore the price considered to be the fairest during any trading day. The POC allows us to estimate Inventory conditions of our competitors. If the POC does not migrate in the direction of the Price auction it is clearly a sign of traders getting too Long or too Short. In addition, if Price departs the POC and does not come back we need Volume in the market to confirm the move. It helps to check the position of the POC after 3-4 time (30 minute) periods and also note if it is above or below the prior day's Close.
The migration of the fairest price at which business is being conducted is of great importance in monitoring longer timeframe activity (greater than day timeframe) in any single day. Also, be careful if the market opens lower/higher from a very Prominent POC; to move and stay away from a very prominent POC or fairest price at which business was being conducted it usually requires above average volume. Here are some observations regarding prominent POCs • Once a very prominent POC has been revisited, I begin looking to see if a directional auction can get underway. • A trade that starts with the POC and moves directionally is often a secure trade that doesn’t get reversed. • The odds of reversal are higher when a trade develops away from established fairest price or POC and continues away for a few periods. • Another secure trade is often one that begins away from the prominent fairest price and immediately begins to auction back to that level. If you observe a late day spike that occurred following a late news announcement from a formation with a very prominent POC - the odds of immediate downside/upside continuation are low. ANOMALIES : Anomalies are often the result of forcing action such as short covering and long liquidation-market action that doesn’t always allow for rotational, investigative auctions. They produce high odds of being revisited, however, very often, Anomalies are not corrected or repaired on the following day. With respect to Anomalies, observe the following - is the market advancing or declining smoothly; for example, if the market was advancing, anomalies lower the odds of upside continuation.
Reversal - The cessation of a directional one-timeframing (e.g. higher high, higher lows) mode is, very often, the beginning of a reversal. Following the cessation of one-timeframing along with an outside day the odds are high that the market continues in the direction of the Close. Spotting Trend Days Identifying Trend Days is always easy once the Profile has developed for a few periods. However, if you look for these combination of events as the trading day unfolds - it will keep you from fading Trend Days : 1. Is the market breaking out of a balance area or trading range - odds are high that it can develop into a Trend day 2. Is the day before a narrow range day? 3. Is there a large Opening Gap as the market begins trading? 4. Was the Opening an Open Drive i.e. did the market sprint higher or lower out of the previous day's range and/or balance area in the first hour of trading? 5. Is the market 1-timeframing for several periods in a row? 6. Is the initial Volume above average? 7. TICK Readings of +/- 1000 to1200 as the market is sprinting higher 8. Sustained or increasingly extreme Advance/Decline numbers Poor Highs and Poor Lows Poor highs are often associated with markets that have gotten too long - particularly when short term traders are controlling the market and suddenly find themselves with too much long inventory - the uncomfortable longs grasp at rallies to previous highs to liquidate their long positions. Other traders watching price go higher perceive that there is less risk and go long; however, lack of follow through often causes these positions to be liquidated. Example: The recent rally to 1705 on Aug 2 & 5, 2013. When the long-term auction fails to show completion it often occurs because short-term inventory is too long; on each subsequent rally these shortterm traders quickly become nervous sellers, which restricts the advance. Liquidating breaks, particularly in the S&Ps, often occur from poor daily highs. This is why you will read or hear; “the market needs to break before it can rally”. The break flushes out the weak hands, which are then replaced by stronger buyers. Poor lows are often associated with markets that have gotten too short; shorts grasp at a return to an earlier low to cover. When this occurrs, you need to learn to shake off the lack of a buying tail as the lack of the buying tail may in fact be your indication to go long. Laggard short sellers have also likely contributed to the inventory imbalance. Markets go through a process prior to becoming too long or short. Observe and look for 1. Tempo—may have been slow and grinding as the auction attempts to probe higher/lower. 2. Rotational environment—the auction may be been in a tight range where traders were selling every rally or buying every break without getting much downside/upside follow thru. Poor highs and lows are more common on very slow days that are mostly dominated by very short-term timeframes; it logically follows as these traders very often automatically buy at earlier lows and sell at earlier highs. It is also innately intuitive to buy below value and sell above it. The most common market conditions for poor highs and lows will occur on balancing days or on very low volume days; the low volume is an indication that the longer timeframes are absent.
