reason
Dialogue on the Two Systems
37 Years of Excellence in Auction Market Research
CISCO Futures
1-303-306-1521 1-800 800 7227 Fax 1-303-306-1572
http://www.cisco-futures.com
dljones@cisco-futures.com
Dialogue on the Two Systems: Holism and Objectivism
Market Profile versus Value Based Analysis
Donald L. Jones
Copyright CISCO Futures 2007
Subscribers to the CISCO Short Course for daytraders are permitted a 15 minute
question session per week. This dialogue between student and teacher concerns the
fundamental principles of Market Profile as initiated in the CBOT Market Profile
manual, 1991; contrasted with the Value Based Analyses developed by CISCO. As such,
this discussion is of general interest to all traders and is shared on that basis.
Student:
Refer to SF8 Nov 13 2007 Market Profile, what is the open type?
(open-test or open-reject-reverse).
Refer to SF8 Nov 14 2007 Market Profile, market had a open-drive day.
G bracket registered the strongest move after initial balance and with
extensions.
Teacher:
Where in our lessons do you find "open-test" or "open-reject-reverse"?
This sounds like it came from Mind Over Markets, 1990. MOM is a reference
we give, along with CBOT Market Profile 1991. Profile trading, as introduced
by Steidlmayer and clarified to some extent by MOM is pattern recognition
and holistic interpretation of what you see in the profiles. The Dalton group's
new book, Markets in Profile, 2007, is even more holistic than the earlier two.
I initailly tried the holism path and found it impossible to read the market
objectively. Steidlmayer knew the players personally in the pit. As an
intelligent observer he could figure who was in control, etc. I doubt
that he could do that in todays electronic markets.
So, by 1987 my path diverged from holism to objectivity. First I found that
value area, by the CBOT definition, could not be calculated for any but
CBOT markets. I researched the TPO value method and that is now the standard
for the industry.
Next I realized that one day's profile could be understood only within
the context of the market as a whole, i.e. the Market Condition. That
led me to develop the
Overlay Demand Curve to determine whether the market is in balance or not.
The critical point here is that the reference points
used in the holistic interpretation, such as value area, are NOT valid
unless the market is stable, i.e. in balance.
Remember, the basic premise of market profile, the foundation,
is that the bell shaped price-volume curve forms a gaussian
distribution and value can be found (defined) as the first standard deviation
of that price-volume distribution. If the price-volume curve is not bell
shaped, obviously it is incorrect to apply gaussian statistical analyses. Since
bell shaped price-volume curves only occur in balanced markets, it is necessary
to have a tool, like the Overlay Demand Curve, that identifies balances.
(Read the new article
in the References Section of our site 'Three Day Balance Rule'.) Even in an
overall 5 Day Balance one or more days may fail the bell-shape test.
So what our course is about is an objective, scientific use of the data.
We identify balances and generally require that the data we use in our
analyses are valid for the their application. This is admittedly more restrictive
than reading patterns, but it is repeatable and not biased by the observer.
Our starting point is 'data validity' for the job at hand, whatever it might be.
Many of the profile reference points offer valuable ways of interpreting the
data, SO LONG AS THE PRE-CONDITIONS FOR THEIR USE ARE MET. Obviously, if you
are beginning with a market not in balance, not meeting the pre-conditions
set by Steidlmayer/CBOT of a bell shaped, gaussian distribution; then your
subsequent interpretation of the meaning of the reference points is in doubt.
The real danger, as I see it, is that we have come to expect too much from each
piece of data! Our ideal is to take a reference point, say value area or
initial balance, and predict the coming market activity; or to be able to compare
one day's value with the next to explain and project the market's behavior.
This is our most
fervent wish, but reality throws doubt on this premise. If we could read
markets, as demonstrated by Steidlmayer in CBOT Market Profile 1991, we
would hold the keys to untold wealth. Reality says "you are in a complex
environment and it is highly unlikely that any one or two market elements
will insure your success. (In fact, with Value Analytics we typcally use some
15 reference points as flow variables, summing over three days to find internal
directionality, market bias, etc.)
You illustrate that ideal wish in your next question ('the low of G should
hold').
Student:
What are the odds that G bracket low would hold for the day? I reason that
the big boys started the move in G, so the low of G should hold. Is this
a flawed reasoning? Or only valid in open-drive day?
On the same day, the profile has a P form structure. Market managed to close
above the Auction Point (F bracket extensions) and on Nov 15 it opened at 1074.
Normally selling on this day in the opening has brought handsome profit but
not on Nov 15. According to Steven Hawkins if the market closes above Auction
Point, the big boys might defend their position at least the first one and a
half hours next trading day and that was what happened on Nov 15.
Teacher:
Your reasoning is of the sort that makes the profile so attractive. If
you can achieve the predictability and understanding ('odds that it will hold')
you wish for, and Steidlmayer tends to show in the CBOT Manual, then you are a master
trader, indeed.
Data unfit for the job may still give you a positive trade (trading blindly offers
a 50 - 50 chance of picking the right direction). So you tend to believe the invalid
data when it works and feel that the wrong trades are because you lack something
in interpretation. This psychological bind affects many traders using moving averages
and oscillators and other invalid methodologies. The "if I had just..." sets in,
when in fact it is the method that is flawed.
The P, b formations are a case of the melding of the holistic and objective
approach. These formations often do illustrate overbought/oversold situations. They
look like what they mean. A market ran up (or down) strongly and then ran out of
demand. Traders in on the move are pleased with their quick profits and are
loath to jump back out. So the market congests until enough traders catch on
that it was short covering or long liquidation, not continuing demand.
A word on the 'big boys'. Back in the 1980's and earlier the trade (locals, commercials)
had more money than the public. That has changed. The public now has much more money
and can drive markets like never before. It used to be that the commercials were 5 or
ten percent of the trade. But they could move the market because of their
ability to place a big trade at a market tipping point and drive price. Today, the
electronic market commercials make up maybe 40 percent of the market. It seems that
these 'commercials' are the hedge funds and no longer a monolith like the commercials
in the pit. The 'big boys' of today appear to me to be behaving largely like the
public and are not the fearsome monolith of before.
Student:
Compared to my other successful trades and all the times market either
close below Auction Point or no range extensions in P form structure right at the
top. Is Auction Point a valid condition for this type of setup?
The purpose of these questions is that I like to have a reason for my trades,
win or lose. I was long on Nov 13 at F bracket 10536 stop 10514 reckoned a
open-reject-reverse day and got out near the high. On Nov 14 I missed the
trade when market retested G bracket low just shy of 1 cent from my working
order. On Nov 15 I sold in the opening with 5 cents stop 1 cent above Auction
Point and I got stopped out in D bracket. I re-entered to sell in E bracket when
market broke 1073 stop just 1 cent above previous day Value Area Low at 10746.
The trades partly based on P form at the top as well as TCP single print from
1059 to 1073 and my second trade got stopped out too then I called it for the day.
And I need your experience and long observation of market profile to guide me
on the reasons I have concocted.
Are these sound or simply flawed?
Teacher:
By Auction Point I assume you mean Point of Control (POC), the high TPO price.
Once again we come to the door of data validity. Is a one-day measure of POC
reliable? The answer, 'not always' is easy to demonstrate a failure. Imagine a market
that opens and trades up one price tick each half hour. At the end of the day
the profile is a straight, slanted line with one TPO for each price. Where is
the POC from which the value area calculation is begun? There is not one. So
value is not defined.
Another approach is to
examine the profiles that are elements in a balance.
For example, in the five day period Aug 30, 2007 to Sep 6, for UU:
Date VAU POC VAL
Aug 30 146675 146200 145825
Aug 31 148075 147650 147300 VA above Aug 30 ? Is this a trend up?
Sep 4 149525 148725 148325 VA above Aug 31 ? Is this a trend up?
Sep 5 147700 147450 147200 VA below Sep 4 ? Is this a trend down?
Sep 6 148200 147925 147600 VA within, ends above Sep 5
In this five day period, the profiles and value area are all over the place.
Following the POC movement would mostly keep you out of sync with the market.
But, this is a 5 Day balance! Groups of three days usually show balance for each
balance group. Day-by-day measures are quite often invalid for trading guidance
the next day.
It is as easy to find a balance period comprised of quite well behaved profiles.
The point is that both types exist and relying on a simple rule 'if the market
closes above Auction Point....' may work part of the time and part not. You
must know your data well enough to know if you can rely on simple rules that
can be devised for well-behaved markets or not. One way you can keep track is
from the volatility for your market. This is listed on the Visual Graphic display.
Over a period of
time you can come to know what high volatility is. If you are in a period of
high volatility, the simpler relationships that work for quiet markets are
unlikely to work now.
As noted, I am doubtful about recognizing patterns such as open-reject-reverse
days and the like. Is there proof that such patterns are meaningful and more,
that you can recognize them on-the-fly? Presumably, a database study of many
open-reject-reverse cases could be made and then you have experimental proof of
the methodology, win or lose. But could you devise a hard and fast criterion
for testing? Would you have to employ a 'valid data' rule that would cause you to
discard some cases where the pattern exists but the data does not support analysis?
Defining 'Day Type' illustrates the holism problem. Day Type is a starting point in the Market
Profile scheme for profile analysis. The analysis begins by recognizing the profile form (day type)
which tells you who is controlling the action (short time frame or long (other) time frame).
In the words of Mind Over Markets, pg 19:
...Market Profile as a whole tends to fall into readable patterns in the day
timeframe, determined by the degree of involvement of the other timeframe
participant. These patterns, when properly identified, can increase the
day trader's success, as well as provide information regarding what the market
is trying to do in the longer term.
CBOT Market
Profile, 1985, listed two day types. CBOT Market Profile, 1991 had three.
Steidlmayer on Markets, 1989, lists six. MOM, 1990, has nine. Steidlmayer on
Markets, 2003, lists five. Markets in Profile, 2007, does not have an index
item for Day Type!
The primary writers in the area do not agree with each other or even themselves
on the number of basic day types that exist. So, how many day types are there really?
My answer: there are as many day types as you want to develop.
That is one of the problems with pattern recognition.
Your patterns may be different from the next person's. If the patterns are
arbitrary, dependent upon the viewer, where is the foundation, the consistency?
Advice:
First learn what we are teaching. Be objective about the market's data and
how to be sure that it can be reliably used. Go back and read the article 'Three Day...'.
Understand Market Condition. Learn the role of profile reference points
in understanding the finer points, the internals of markets. Spend time on
Value Analytics, it puts the Market Condition and profile reference points into context.
After you understand the data, the hard facts, then include your own experience.
Do not blindly believe anyone else's experience without validating it yourself.
If you cannot validate it, you cannot use it intelligently. Stick to what you
know and can prove. Probably every good trader has a base of specific knowledge,
learned in the trenches. This can lead to some holistic decision making, but
that holism is based on hard facts (understanding the data) and personal experience.
CISCO's role is to teach you the hard facts of validating futures data and to
help you sort the wheat from the chaff. We provide you the analytical tools
for the job. Understanding your market and the use of the tools is critical.
However, your trading expertise comes from you, not CISCO, not Steidlmayer.
Best regards,
Don Jones