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In our earlier brief discussion of Noise Traders Noise Traders,
A Review we pointed out that the informed trader, an insider, has
better
sources for valuing stocks, futures and other trading instruments than the
public or uninformed
trader. Uninformed traders, the public, are termed "Noise Traders".
Learning to Trade Value Instead of Price Movement
Short Timeframe Value from the Meta-Profile
Internet http//www.cisco-futures.com
Email dljones@cisco-futures.com
Copyright CISCO Futures October 17, 2004
We then went on to list a composite description of a noise trader.
"A typical composite noise trader is 1) a small speculator, 2) who has no special
(fundamental/inside) information, 3) who's trading increases volatility and
4) may be a chartist, a technical analyst, a trend follower, etc. Further,
the odds are against noise traders because informed traders are often right
and the noise trader is on the other side of the transaction."
Lastly, we suggested that the noise trader could become a value trader, i.e.,
an informed trader, a defacto insider.
The Market Picture
It is a given that informed traders allied with a large trading entity
have numerous assets to draw from. They gain information from
their firms' market
analysts who have an intimate knowledge of an industry or stock (or e.g.,
grain traders in futures) and from their contacts within the trade outside their
own company. Also they have their own personal knowledge of the markets.
On occasion they may obtain access to truly insider information. A reasonable
question might be: "how could a mere public speculator compete with such an
informed trader"? The answer requires some background on markets.
First, think about the stock market and its thousands of US equities,
derivatives,
bonds and so forth. The futures market is more limited, with some 400 U.S.
futures plus derivatives plus foreign markets. In equities
there is strong focus on those
stocks in the S&P 500, maybe even the Russell 2000, where the informed
traders are active. Even in these most active markets there is certainly
not insider information, or trading information every day. Likewise, in
futures, the commercial traders pretty much stick to the front delivery,
ignoring the other three-quarters of the market. Consequently, the uninformed
public trader need not butt heads with an insider very frequently.
Secondly, markets change price much, much faster than fundamental valuations
can change.
Economists have studied this feature, often ascribing it to some sort of
herd effect. In fact, the market is a complex, self regulating mechanism
that responds to feedback from trader activities. While there certainly
exist valuations of stocks and commodities calculated from the
fundamentals, these are longer term (years of dividends, a growing season,
etc.). In the shorter term of minutes, hours, days, weeks and sometimes
even months, market demand sets value.
Traders focus on the short term, not the long term. Changes in
self-valuation by the market are the basis for trading profits or losses.
The "Noise Traders" article briefly noted
that Meta-Profile and the Overlay
Demand Curve offered ways to find market
value. Market Value is described by price but it is not a price. For instance,
think of a trading day, say April 1, 2004 for the Dow Jones Index. Split
the day into approximately half hour time periods from the open at 7:20 am
to the close at 3:15 pm. Give each time block an identifier: y for 7:20 to
7:30, z for 7:30 to 8:00, A for 8:00 to 8:30, B for 8:30 to 9:00 and so on
alphabetically for the rest of the day, where N identifies trading from 3:00
to 3:15 pm. These letters are called TPOs (time-price-opportunity, or that-
price-occurred). TPOs show time - trade matches. As you will see, value
is price-over-time and the TPOs provide the measure. The price-time graphic
is called a Market Profile if the data are from the CBOT Liquidity Data
Bank. If the data are from ticks, a CISCO Meta-Profile is the result.
Meta-Profile for the Dow Index on April 1, 2004.
META-PROFILE REPORT FOR 04 01 04
COMMODITY -- DJIA (CBOT) DAY JUN 04 LENGTH OF FIRST PERIOD = 10 MINS
Half - Hour Bars = Segmented Auction TPO/TPT
103900 D E 103900 DE
103850 D E 103850 DE
103800 D E 103800 DE
103750 D E F K 103750 DEFK
103700 D F J |K |L P 103700 DFJKLP
103650 C | |G | | |J |K |L | | |P 103650 CGJKLP
103600 C | | |G |H | |J |K |L |M | |P 103600 CGHJKLMP
103550 z C | | | | |H |I | |K |L |M >N >P 103550 zCHIKLMNP
103500 z |C | | | | |H |I | | |L |M |N |P 103500 zCHILMNP
103450 |z |A | |C | | | | |H |I | | | |M |N | 103450 zACHIMN
103400 |z |A |B |C | | | | |H | | | | |M |N | 103400 zABCHMN
103350 |y |z |A |B |C | | | | | | | | | |M |N | 103350 yzABCMN
103300 A |B |C | | | | | | | N 103300 ABCN
103250 B C | | | | | | 103250 BC
103200 B C | | | 103200 BC
VALUE AREA: Central 70% of TPOs
UPPER 103670
LOWER 103320
Fig 1. Half-Hour Bars (left) and Meta-Profile (right),
June 04 delivery, Trading on April 1, 2004.
The vertical bars on the left, labeled z, y, A, B,... identify the
trading range for each time period from 7:20 am to 3:15 pm.
The vertical dashed lines accompanying
the half-hour bars are a running measure of the developing value area,
as explained below in item 4).
Meta-Profile, letters on the right, give price and time of day that
price was traded (example: 103250 traded in the 8:30 to 9:00 am (B) period
and also in C period, 9:00 to 9:30.
Features of Fig 1. (From the Meta-Profile)
1) Price 103950 traded in only one period, the high of the day
2) Prices 103900 to 103800 and 103250 to 103200 traded in only two periods
3) Price 103550 was visited in nine periods, the most popular price
4) Seventy percent of the TPOs lie between 103670 and 103320.
5) The shape of the TPO distribution is a single bell shaped curve.
Explanation of Features of Fig 1.
1) Little trading at the top four prices shows the market rejected these prices
2) Little trading at the bottom two prices shows the market rejected these prices
3) 103550 won the day's trading popularity contest
4) The bulk of the trading (70%) lies between 103670 and 103320 which is
named the "Value Area".
5) The single distribution (bell shape) shows balance.
Conclusion: You found the price range the market selected on April 1
for its best estimate of value. Value is not a price, but rather a
price range, 103670 to 103320.
The Meta-Profile has found value for the day of April 1. This value
is, of course, after the fact. What use is it? At the very least your
tracking of value on April 2, tomorrow, has a base in the value area of April 1.
A deviation beyond the value area on the upside signals strength, downside
is weakness.
In other words, a price above 103670 suggests a potential value upside
breakout, below 103320
is a potential downside breakout. You now have an up-to-date short
timeframe support and resistance.
For more on Market Profile/Meta-Profile Market Profiles Background.
Longer Timeframe Value from the Overlay Demand Curve
The Overlay Demand Curve integrates several days of Meta-Profiles to
obtain a reading of the market's condition. When the market is in balance you
find another, longer term support and resistance. Again, as with the
profile, the support and resistance prices come from value, not some
price based indicator. The procedure is much the same as with profiles;
you seek a bell shaped curve of trader demand and from that you find
the value.
Figure 2, below, integrates Meta-Profiles for the five days, March 26
through April 1 into an Overlay Demand Curve.
TPO VOLUME OVERLAY AND PRICE ROTATION PROFILE
JUN 04 DJIA (CBOT) DAY
03 26 04 TO 04 01 04
PRICE TPO SUM OVERLAY PROFILE 1=NEAR, 2=NEXT BK,...
103950 2 11
103900 2 11
103850 3 112 <== Upper Limit
103800 5 11122
103750 5 11111
103700 11 11111111222 <== Close
103650 11 11111111122
103600 17 11111111112222233
103550 16 1111111112222233
103500 15 111111112222233
103450 18 111111111222222333
103400 15 111111122222233
103350 16 1111222222222223
103300 17 11122222222222333
103250 18 112222222222333444
103200 19 1122222223333444444
103150 20 22222333333444444444
103100 24 222233333333444444444444
103050 22 2223333333344444444444
103000 18 223333333444444444
102950 13 2233333344444
102900 10 2333333444
102850 8 33333444
102800 5 33444 <== Lower Limit
102750 2 44
102700 2 44
102600 1 4
102550 1 4
102500 1 4
102450 4 4445
102400 4 4445
102350 4 5555
102300 5 55555
102250 5 55555
102200 8 55555555
102150 6 555555
102100 7 5555555
102050 4 5555
102000 4 5555
101950 5 55555
101900 6 555555
101850 6 555555
101800 7 5555555
101750 5 55555
101700 3 555
101650 1 5
101600 1 5
101550 1 5
Fig 2. Overlay Demand Curve, 5 days, March 26 - April 1 2004
The five days in the Overlay are identified by their day numbers,
where 1 is the latest day, 2 is March 31, 3 is March 30, 4 is March
29 and 5 is March 26. The latest four days 1, 2, 3 and 4 form a
recognizable bell shaped curve with limits at 103850 to 102800,
assuming that at least three TPOs across are needed for a meaningful
determination. The "Upper Limit" at 103850 and a "Lower Limit" at
102800 define the Value Region. You see a four day balance. The
earliest day, 5, was a part of an earlier distribution and has
no bearing on the new balance.
Features of Fig 2. (From Overlay Demand Curve)
1) Price above 103850 will alert you to an upside breakout
2) Price below 102800 will alert you to a downside breakout
3) Prices within the limits are in the mostly noise region
4) Although in balance, the balance is tending toward the top
5) Close is near the top
Explanation of Features of Fig 2.
1) The shape of the balance implies continued upward thrust
2) Market condition is balance, with preferred trading to the upside
For more on Overlay Demand Curve Overlay Demand Curve Background.
Understanding Value: Your Transition to Insider Trading
At the end of trading on April 1 you have two sets of value for a
pair of support and resistances.
Overlay Long Term Resistance 103850
Profile Short Term Resistance 103670
Profile Short Term Support 103320
Overlay Long Term Support 102800
At this point you have a market understanding about this market within this
time frame, equal to or surpassing most
insiders. The informed trader has a different data set, one that is
rarely so fine tuned as developing the actual support and resistances
generated by the market itself.
Trading Strategy, an Example
Given the same input, two traders may trade quite differently, as pointed
out in the article Trading Model Development.
In this
section we define a simple strategy based on the axiom: enter on a
breakout, exit on congestion and never risk more than you can afford
to lose).
Trading strategy for the day market of DJ for April 2:
1) We are biased toward the upside
2) Go long as price crosses 103670 from below
3) If entered. set a "disaster" stop at 103320 (the other side of the value
area). This is $400 for DJ, $200 for ecbot
4) Use a congestion signal of three TPOs across (same price for 1.5 hours)
5) Go long a second unit as price crosses 103850 from below
6) Same congestion test as in 4)
7) Keep same disaster stop (update the stop (non-regressing trail) every half hour)
8) If not stopped out or exited on congestion, exit on close
Trading the Next Day: Meta-Profile for DJ, June 2004, April 2, 2004
LENGTH OF FIRST PERIOD = 10 MINS
META-PROFILE REPORT FOR 04 02 04
AND SEGMENTED AUCTION
COMMODITY -- DJIA (CBOT) DAY JUN 04
Price Brackets Segmented Auction
104820 zB z | |B
104800 zB z | |B
104750 zAB z |A |B
104700 zAB z |A |B |
104650 zAB z |A |B | |
104600 zABHIP z >A >B | |H |I | P
104550 zBHIP z | |B | | | | | |H |I | | | |P
104500 zBCHINP z | |B |C | | | | |H |I | | | | |N |P
104450 zBCFHIJKN |z | |B |C | | |F | |H |I |J |K | | |N |
104400 zBCDEFGHJKN |z | |B |C |D |E |F |G >H > >J >K > > >N >
104350 zBCDEFGJKN |z | |B >C >D >E >F >G | | |J |K | | |N |
104300 zBCDEKMN |z | B |C |D |E | | | | | |K | |M |N |
104250 zCDKLM |z | |C |D | | | | |K |L |M | |
104200 zCDLM |z | |C |D | | | | |L |M | |
104150 zCDLM |z C |D | | | L |M |
104100 zCLM |z C | | | | L M
104050 zCL |z C L
104000 yz |y |z
103950 y |y |
103900 y >y |
103890 y |y |
103880 y |y |
103750 y |y |
103740 y |y |
103730 y y |
103710 y y |
103700 y y |
Fig 3. Mets-Profile for DJ Jun 2004, April 2, 2004
This profile and the 10 minute tick bars in the Appendix permit tracking the
specified trading strategy throughout the day.
Review of Trading on April 2
1) Market open at 103710, is higher than the first entry at 103670.
Low of the day, 103370, is above 103670, so that trade never was in reach.
2) The second entry, 103850, was triggered in the first ten minutes of
trading, as shown in the tick bar Appendix below.
3) Enter at 103880 in y period, because of the gap, as shown on Fig 3.
Trailing stop at end of y period 103640
4) We now become a congestion watcher for exit, moving our trailing stop at the
end of each period.
a) z period (7:30 to 8:00) moved up to 104600 in one big run (1 TPO across)
Trailing stop 104200
b) A period (8:00 to 8:30) retraced a bit from high, last = 104750 (2 TPOs across)
Trailing stop 104350
c) B period (8:30 to 9:00) opened at 104750, the close of A period (3 TPOs across)
At 104750 three TPOs are lined up, meeting our congestion test.
Exit at 104750
Recap
Analyzing value provides real measuring points, information generated
by the market itself. Value gives a picture and understanding of a
market that price alone cannot. An even more complete view of the
market can be gained for deeper market understanding, by including
additional market reference points (value area and value region price
locations are examples of reference points). For the
theoretically inclined the entire picture as we currently understand it is at:
Auction Market Theory.
An extensive set of study material exists on the CISCO website
at "Background Reading" and in the "Auction Market Resource Center" at the
top of the CISCO homepage.
A four month trading applications course for day traders is described at
ShortHomestudy Page.
A longer course oriented toward swing trading is described at
HomeStudy Long Course.
Yes, by understanding value the uninformed noise trader can enter
the ranks of the informed. Value analysis gives you both entry points,
exit points and risk measurement data.
Disclaimer
Do not be misled by the results and ease of the sample trade. While it was
not preselected other than by the requirement for a breakout trade
in the timeframe in which this article is being written (April, 2004), it
is an exceptional rather than average case.
In fact something like half of the breakout trades, initiated like the
one above, lose money. The wise trader can be profitable in a 50 - 50
win environment by limiting losses (disaster stops, trailing stops)
while letting profits run until the market suggests the run is over.
The sample trade is a case in point. A disaster would be 400 points
maximum, the gain was 870 (104750 - 103880).
Trading is a profession and like other professions requires a learning
curve. In a more complicated trading environment than the sample, a
number of decisions might be required: congestions are often not so
easily read as the case illustrated. Other factors such as volume,
volatility and many more can be applied in trading decisions. Learning
the nuances takes time.
Still, value trading benefits the trader by providing direct
information on the market. Valid information gives the intelligent
trader an edge. Success is probably more the result of risk control
and basic market understanding than model development. A trader with
aptitude and the proper work ethic can become, effectively, an insider.
Appendix: 10 Minute Tick Bars
DJ DEL-MO/YR 06 04 MO/DY/YR 04 02 04
OPEN,CLOSE 103710 104580
HIGH,LOW 104820 103700
# Ticks 505
TPO First High Low Last Ticks
7:20: 0 y 103710 104040 103700 104040 33
7:30: 0 z 104050 104820 104000 104600 31
7:39:59 z 104600 104700 104500 104510 10
7:50: 0 z 104400 104650 104400 104600 10
8: 0: 0 A 104630 104650 104600 104650 8
8:10: 0 A 104650 104700 104650 104700 3
8:19:59 A 104750 104750 104720 104750 6
8:30: 0 B 104750 104820 104650 104730 23
8:40: 0 B 104720 104720 104450 104480 25
8:49:59 B 104480 104480 104270 104450 24
9: 0: 0 C 104480 104520 104250 104250 15
9:10: 0 C 104380 104400 104250 104250 17
9:19:59 C 104280 104280 104020 104150 20
9:30: 0 D 104170 104250 104150 104250 14
9:40: 0 D 104320 104380 104320 104350 8
9:49:59 D 104350 104440 104350 104370 4
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