Oct 132010

In A look back on my journey – Part 4, we took a peek at my trading journal.  I haven’t received much feedback on that so I hope you found it interesting.  I had reservations about sharing it since it was a bit personal but at the same time I figure if it can help others and motivate them to journal then it’s a worthy cause.

One other thing I want to point out is that Part 1 of this series didn’t start at the beginning of my trading.  I’ve been doing this nearly full time for almost 3 years.  But prior to the eminiwatch method I was jumping from one thing to the next and was totally lost.  So that part of the story isn’t so interesting.  The eminiwatch method was great in that it gave me a framework to interpret the markets.  And as I said in Part 4, this framework was often conflicting and sometimes not able to adapt fast enough to changing market conditions.  I think the multiple timeframe cycle framework was a very important part of the learning process but it was time to take the training wheels off.

2010 was a great learning experience for me.  I took the first few months to watch as many webinars as I could and read as many books as I could on market profile and order flow.  I had been trying to work that into the eminiwatch method.  It was now time to see what I could do without the multiple time frames & cycles.

I don’t want to too much about market profile because there are already some great resources for this.  So I’ll focus on how I use it.  In a nutshell, market profile was invented back when they didn’t have realtime volume information.  Time & price combined were used to approximate volume.  So if time spent 2 hours at one price and only 30 minutes at the other, we could say the former had 4x more volume than the latter.  Areas of high volume mean lots of trade happened at that area which means “acceptance” of the price.  Areas of low volume show that traderes didn’t agree to trade there and there was “rejection”.  This is the basis of auction market theory – the market is constantly seeking out areas of acceptance in order to facilitate trade.  Today we have realtime volume information which supplements the market profile approach and some would even say revolutionizes it.

When I use market profile I mainly look to see what the recent accepted and rejected prices are.  I look for balance areas.  When the market is balanced you want to fade moves to the edges of the balance area.  When the market is imbalanced you don’t want to fade it, but rather enter on a pullback.  Sounds simple but it’s not because the market goes from balanced to imbalanced and back and it’s hard to recognize it real time.  For example you can fade a move to the top of the balance area only to find the market goes imbalanced and stops you out.  Then you buy a pullback only to find the market is now going balanced and stops you out again.  Since we can’t really know if the market is balanced or not right now, in real time, so all we can do is guess.  For this reason it’s important that winners be larger than your losers and for to have permission to guess incorrectly (remember the issues I wrote about in Part 2?).

Since market profile typically uses 30 minute periods, it also serves as a 30 min chart.  Desktop space is limited so a chart that can serve multiple purposes is very valueable.

Here is the market profile for the bund today:

Yesterday October 12, the market opened in the A period.  It then went up really high to the D period, and then spent the rest of the European session balancing (also called rotating) in this area.  Then later when the US markets opened, it “broke out” to the downside where it then balanced again into the close (the red asterisk).

Today, October 13, the market tried to go up and found sellers, then tried to go down and found buyers and then balanced in between those two.  I was a seller at the high and a buyer at the low.  I was fading the moves.  At the time I didn’t know the market was going to be balanced, it was impossible to know that.  I’m not big enough to force the market to do what I want, all I can do is watch what the big traders are doing, try to pick the stronger side, and trade with them.  And that’s exactly what I did, using tools which I’ll write about later.

Here are the two trades:

The first trade was a short at the top of the C period and the second was a long at the bottom of the D period.  This just happened to be a day where I guessed right twice.  Yesterday was not so good.  I won one trade and lost four, but since I kept my losses small I ended up with a loss of only 3 ticks.   I mention this because I don’t want to make anything look easy.  I’ve been studying market profile for 10 months now and it’s still not easy.  But I’m improving.

As I’m writing this I’ve been watching for setups on the Bund & Euro.  The Bund went up towards the high again and made a double top so I took another shot at a short.  It was not a perfect setup, in fact I probably shouldn’t have taken this one.  In the market profile chart above you can see the dotted red line at 131.36.  This is called the DVPOC which means developing point of control.  This is the price that has the most volume today.  I entered my trade at 131.41 which meant my target was on the other side of the DVPOC.  Since the DVPOC represents the price at which traders have agreed on price, it’s likely they’ll continue agreeing on 131.36 and that means the probability of my target being hit is lower than it’d be if my target was above the DVPOC.  Remember we need disagreement for price to move and we’re least likely to find disagreement at the price which has had the most agreement right?  Well that depends but more on that later.

So when I saw price stalling at the DVPOC I got out with 4 ticks.  I need to pay more attention next time.  If you didn’t understand all that don’t worry, you will once you’ve learned about market profile.

Here’s the updated trade list:

That makes 3 trades in 2 hours.  It takes a lot of patience to wait for the good setups.  But the result is 3 winning trades that didn’t go against me more than 2 ticks.  It pays to be patient.

I’ll be writing about the other factors that went into these trades, but I will say I didn’t need multiple timeframes or cycles.  Unfortunately I can’t pull up the cycle charts for the Bund to compare.  Maybe the cycles gave a perfect setup and maybe they were completely wrong.  The key is that I don’t need them if I can see it for myself.

There are clues to everything the market is doing but they’re often subtle and even invisible to the untrained eye.  Indicators only further obscure this information by taking our eyes off what’s important and having us watch “squiggly lines”.  So it’s well worth the investment to learn to hear what the market is saying directly from the source.

To learn more about market profile, James Dalton is the expert.  He has written two books and has recently started blogging.  I cannot recommend these books & his blog enough.  They should be required reading for all traders.

Next we’ll look at an evolution of the market profile concepts.

Continued in A look back on my journey – Part 6 – Volume Profiling

  9 Responses to “A look back on my journey – Part 5 – Market Profile”

  1. Great post Michael, “the market is constantly seeking out areas of acceptance in order to facilitate trade.” – so true, so true. I look forward to see your ideas on tracking the “Big Elephants” – delta maybe?

  2. I’ve been trying to do that for a long time. Delta is not helpful because the smart money will use a combination of limit orders & market orders. Delta only shows the market orders.

  3. In order to get price to move someone has either so buy the offer or sell the bid – if everybody is waiting with their limitorders nothing will happen ;o)

  4. This is true however professionals don’t just start buying with market orders and drive the price up on themselves. They accumulate before hand and when they’re finished accumulating then they begin the mark up phase. So while they’re accumulating the delta can be negative telling us there is selling, and there is selling. But the sellers are not the ones who will be in control. It requires a lot of context.

  5. Thinking out loud now… agree that there might be accumulation in a selling trend where the Elephants accumulate with limit orders on certain (dynamic) levels until there are not sellers enough to go further down. In delta terms that would mean negative delta all the way down until “saturated”. No more sellers means flat and then you need to “ingnite” some buying to work up prices to a level exceeding the average buy price on the accumulation made during the down move. That means a shift to positive delta. Then the question is what signs can be observed to reveal when and where? Hmmm…

  6. This is pretty much what I’m looking for. I use to use the pro bars to alert me to this. Now I’m using the volume footprint (ladder), and I’m currently working on learning to see this directly on the DOM.

  7. Another issue with Delta that each data provider has different results. This is most noticeable on the volume ladder charts. I have compared data from IQFeed to Zenfire and the data is very different. They disagree about whether trades happened at the bid or ask.

  8. Hello.

    I have been reading thru your series and also looking at F71.
    I’m still a complete novice in terms of MP etc, but just a couple of Q, after reading your posts and some background on MP etc.

    1. The VPOC, HVN, LVN etc are all areas from previous days ? But they can come into play in the current live day, so we are looking for price to react to those levels, I presume. If there are a number of levels say 1 or 2 points apart, does that mean you could get caugght in a chop as the r/r is also not that great ? So would you decline a trade in these areas until it has cleared them and the distance to the next area is far enough to give a decent r/r ?

    2. As the current live day unfolds and today’s price action forms it’s own swing highs and lows and double tops or whatever. Do these areas become important to any trade decisions ? Say for example the market is pivoting at areas other than VPOC, HVN, LVN etc ?

    3. In general terms : Market Profile is giving you S/R areas based on price action. BUt it has deemed price important based on how much volume was done at that price. So you the ‘centre’ which had the most volume and the ‘edges’ which had the least volume. And all 3 of these areas can be support/resisatnce areas in the current live day. is this a fair (if simplistic) summary ?

    Thanks for your time.

    P.S > Will add you to my blog roll, if you are ok for me to do so ?

  9. Hi Amarji,

    Thank you for your great questions.

    1 – There are typically only 1-2 HVNs per day and those are surrounded by LVNs so figure 2-4 LVNs. The low side would be for a more balanced, small range day and the high side would be for a volatile day that had two balance areas. So it’s not likely to have levels 1-2 pts apart. If it does happen that I have a level before my first target, I will usually skip the trade. I call this an “obstacle” and I want to avoid them.

    2 – Yes, these are very important. They often occur near the MP levels of the day before. When this happens there is “confluence”. Confluence is very important. If I see several support levels in the same area then I believe that support area has a higher probability of holding.

    3 – That’s a good summary. I don’t remember if I mentioned it in the post but I classify levels as likely to be “accepted” or “rejected”. LVNs are always in the rejected category (but they can be accepted) and the HVNs can be either.

    I appreciate your offer to add me to your blogroll, thanks.

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