'Markets In Profile': Detailed Book Review

[Frank]

Chapter 5: Long-Term Auctions

This chapter is in some ways the lightest content chapter in the book, in my opinion. Nevertheless, there are a few good (inter-related) concepts in this chapter:

1) The market price only has to be ‘fair’ in the day timeframe.
2) On longer timeframes, markets do not go directly from Bull Market to Bear Market or from Bear Market to Bull Market. They enter intermediate term ‘Brackets’ in between bull and bear markets.
3) Longer-term players may disregard short-term balances that spawn short-term auctions. However, traders and investors of all timeframes should pay careful attention to higher timeframe breakouts as they include participants from all timeframes and can therefore bring large momentum moves

Long-term charts (auctions) are for context. You don’t act on indicators or patterns based off of long-term charts in reality but they give you an idea as to remaining cognizant of what can happen if and when all timeframes align at key points in time.

This is not from the book but is a good analogy I got from another trading book that fits here. This is like being at the ocean and the waves are going in and out. Imagine you are watching that little whitewash current that sucks the water in and out before a wave comes in. Well, sometimes that little current is running in and out and you think you understand the rhythm. But then occasionally that little current gets sucked out and it runs straight into a monster wave that shoots further up the beach than a wave has all-day. THAT is what can happen if you are not cognizant of what is going on with the long-term charts.

Major market ‘breaks’ are non-linear, they auction VERY quickly once underway. These will not happen very often if you are focused on short-term trading – but when they do – they will be extremely powerful.

A Bull market does not convert instantly to a bear market. An intermediate term ‘bracket’ forms first. The next chapter (chapter 6) is about intermediate-term brackets. Thus, this chapter is really about understanding whether you are in an intermediate-term bracket or in a major bull or bear trend. An intermediate term bracket will feel violent at times. A Long-Term non-linear break will feel stronger than that…

To me, the bigger issue here is watching the daily timeframe in context of the intermediate term trend or bracket (the next two chapters). There isn’t that much more in Chapter 5 regarding long-term auctions except to say --- expect extreme non-linear movement to occur from time to time and be ready for it. The next two chapters: Chapter 6 (Intermediate-Term Auctions) and Chapter 7 (Short-Term Trading) are probably the 2 best chapters in the book.

[Frank]

(Chapter 6 and Chapter 7: Intermediate and Short-Term Auctions/Trading)

Part 1.

Rather than keep this to just intermediate term auctions, lets use the extremely important concepts of this chapter and relate it to all timeframes. I cannot overstate how good this stuff is – thanks to Jim Dalton & Co for writing this book.

Let’s review again these statements:
“Recognizing where you are in the auction process determines your risk/reward relationship.”
“The end of an auction offers the moment of greatest opportunity… risk & return are asymmetric at this point.”
“Auctions complete when the laggards from the last auction are met by the innovators from the new auction.”

Ok, this is Market Profile at its core. Through all timeframes (intraday or longer-term) – you need to understand how an auction ends. By understanding the signs of how an auction ENDS, you will know not only whether to enter a new order --- but also whether to stay with the flow of the current auction (either through holding on or re-entering on a pullback). Later we can discuss how a bracket ends and a new trend begins. For now, lets focus on the former --- when one auction ends.

The market is a series of 2-way auctions. The end of one auction leads to a new auction in the other direction. If you can figure this transition out, you are entering an order with big reward as you are in on the ground floor of a new auction. When you get it wrong, you will know quickly because of how you are ‘marking’ the end of the auction. Let’s get to it.

What is it that marks the end of an auction? (perhaps the most important concept in the book, imo).

“‘Excess’ marks the end of one auction and the beginning of another”

‘Excess’ can be seen in 2 primary ways:
1) A key Buying or Selling Tail
2) A key Gap

Excess occurs when a market makes a dramatic price high or low on low/moderate volume and opposing buyers or sellers react quickly and aggressively by auctioning price in the opposite direction. Sometimes this is in the form of a tail (a strong volume-based rejection) and other times in the form of an overnight gap (a gap that catches a market that got too long or short into the previous days close and has now ‘trapped’ those traders).

Be on the lookout for these two key signs of excess: the tail and the gap. This is so important in understanding the entire auction structure, IMO.

If the recent auction is downward and an auction low has been established with a buying tail, the investor who correctly recognizes the low and buys has a low risk/high reward (asymmetric) position. Why? His risk is that the 1-bar tail gives way (or less risk if you can fine-tune entries and re-enter if necessary). The reward for being right is an entire auction in the opposite direction.

In a pure sense, the absolute ideal location for entry is precisely on the price bar where an ‘excess low’ or an ‘excess high’ forms. This is the price bar where laggard meets innovator and this is where you would ideally like to be.

This is not just from Daltons chapter now, this is my own experience inspired from this (excellent) Dalton chapter.

Much of the time, the key ‘innovator-laggard intersection bar’ will be in the first 2 hours of the trading day. The most often will be the opening 30-minutes of the day, especially if the market has reversed down (from up auction to down auction). In general though, be on the lookout for a key buying or selling tail in the opening 2 hours – with particular emphasis on the first 1-2 30-min bars.

Regarding the opening 30-minute bar, I should also point out that any strong movement off the opening price can be considered similar to a ‘tail’ in and of itself. Range Expansion off opening price is an important concept. Though not really a big part of Daltons book, think about this as you study 30-min bar charts of morning reversals.

Another thing is that a tail in the morning session is best if it has also exceeded the previous days high or low. That is, a good buying tail will rinse below the previous days low and create something of a double tail --- a 30-min tail AND a tail on the daily chart. Likewise, a good selling tail should go above the previous day high and get ‘rejected’ by higher timeframe sellers --- and most of the time this will occur early in the session. The previous days high and low are very important ‘reference points’ in market profile.

The second form of ‘excess’ after the violation/tail is that of a gap. : “A gap at the end of an auction that occurs in the direction opposite the most recent trend signals a reorganization of beliefs. Market participants have changed their perception of value so dramatically that they simply begin trading at a completely different price level.”
2 things with gaps.
1) Gaps represent ‘overnight inventory’ --- traders who have entered positions overnight will generally be ‘weak-handed’. If price does not move in their favor quickly, they will panic out. This is part of the reason the first 30-min bar marks the high or low of the day more than any other single price bar.
2) Gaps are a bit tricky to enter on. You will need to understand the bigger auction structure or else a key auction-reversal gap will leave you in the dust. A good deal of the time, the market will gap and auction in the direction opposite the gap. Thus, you cannot just chase gaps and label them all ‘auction reversal’. You should just be aware of the key auction reversal gap if the structure of the recent auction also suggests it is losing momentum or is otherwise long in the tooth.

Remember, you will not be looking for tails or gaps in isolation. You will have a lot of context from your other indicators. Essentially, you will be watching the auction accelerate and then mature and then look for your tail/gap reversal signal. Market profile consists of many things that you have to synthesize into a composite answer. What did the histogram look like over the last ~3-4 days? Has the market been soaked of its buying/selling pressure and now poised to reverse? Or is buying/selling pressure still strong? Was volume getting stronger or is it getting weaker? Is the last auction long in the tooth? How did the market close yesterday relative to what it was ‘trying’ to do? In the context of the overnight move with the other indicators, what is the likely state of inventories across timeframes? When you put together these concepts, you get a good idea of where you are in the auction. When you combine it with the tail/gap indicator --- you are now ready to enter an order as you will have located your asymmetric location (the ‘innovators entry’). Even if you miss your ‘ideal’ entry, you still could get something similar to a ‘early adopter’ entry (1 step removed from innovator but still good location in the context of a bigger auction). So long as you understand the structure of the auction and are making entries and exits within that framework --- you will be entering orders with the flow of the current auction.

I realize at this point that I am basically writing a rough draft of something that is no longer a pure book review. Oh well, will just wing it for a while. Eventually, this will get back to the original structure.

[Frank]

Let's looks at a recent 'Excess High' to demonstrate some of these concepts.

This is from March 12th:

March 11th was strong up day as seen in the hard afternoon buying which created an elongated profile. March 12th opened right on the previous days high. After a quick test down periods B & C (the first hour), buying came back in and pushed price materially above the previous day high.

Why would you consider shorting here?

Because:
1) You know that the first ~2 hours of the day are known to often show reversals (periods B-E).
2) Price trades above previous day high, creating the potential for a daily 'selling tail' to form. You do not KNOW at this point sellers will come in. But you know that this isn't a 'innvoator' or 'early majority' level for sure. This is 'asymmetric location' to short. If you are right, you will catch an auction down. If you are wrong, then risk is controlled.

On this day, laggards of the last auction met innovators of a new auction in period E. Period E is the 'Excess High'.

(it turns out that price pushed up into a resistance zone at 1336.50 and this was a natural 'reversal zone' to look for).

[shreem]

Hello Frank, thanks a lot for your great explanation of your resume of this book. In fact, I have like it so much that I have purchased the book and I have begin reading it and it is very good.

As you can see, I am a really big advocate and fan of market profile and how it can be used in trading.

I do really think that a deep understanding of market profile concepts along with a firmer understanding of the auction market theory and volume analysis is a great combination in developping a successful trading plan.

So, thanks a lot for your hard work in putting that for us on this thread

Sincerely

Shreem

[winnie]

Dear Frank,
Your book review is so great ! Thanks for your hard work. As a Market Profile trader, I would like to ask you in your example, do you need to wait for the Market Profile chart to shows a Excess before you short ? That mean do you need to wait for the F period complete before you go short ? However, if you do not wait for F period finish ? how do you know E period is an excess ?
Thanks again for your kind work !

[ckait]

dont get too caught up in what period your in if higher prices are not attracting new buyers the auction is likely nearing it end for the time.

[Frank]

<<how do you know E period is an excess ?>>

good question. you will never really know if sellers (buyers) will show up or not in advance. market profile is really more about understanding some core trading concepts and securing good location for your entries.

In this case, following a day of strong trending action -- the market has very high odds of exceeding the high of that day on the following day. 'Inside days' are actually pretty rare (~12%). Thus, you should not be shorting BEFORE the market exceeds the previous day high. But shorting AFTER the penetration of the high and in periods A-E is now a decent idea to consider.

Here is another concept unrelated to Daltons teachings but a helpful guideline. Once the market picks a direction for the day, it will often continue to go that direction for multiple HOURS. Many times (>50%), the market won't make its FINAL high or low until the final hour of the day. It will just chug and chug and chug directionally for hours --- away from the high or low it made in the morning. Thus, if it does make a high in B-E, you will be sitting on a good position that you can ride for hours.

There are many other concepts that can help gauge the odds. Oscillator divergences, Moving Average regression tendencies on certain days of the week, confirmation from other indices (Dow/Nasdaq/Bond Market etc...).

I will try to get some more of these important chapters (6 & 7) done soon.

[DbPhoenix]

Steenbarger addressed the subject of trend days yesterday in his blog. I suspect you will find it of interest: Bandwagon Effects

[Frank]

I was re-reading some of my earlier posts and wanted to explore one concept presented in context of some recent/current auctions. For now, let's just look at the gaps and ‘value migration’.

The market is a series of 2-way auctions where value migrates one way for a period of time and then auctions the other way. So ‘value migration’ and auctions are essentially one in the same.

You are gauging the intraday order-flow within the context of the order-flow occuring at a higher level. The gaps (and tails) signal 'excess' has occured and 'excess' is what marks the end of one auction and the beginning of another.

Of crucial importance is where the gap occurs. In this chart, I have tried to represent order-flow in terms of action relative to a higher timeframe value migration. Value migrates one way during one auction and then migrates the opposite direction. But value beginning to migrate up during a large value migration down is different than value migrating up after a good auction reversal. Separating these two similar situations is of crucial importance.

This indicator is based on what is happening with current order flow in context of a moving average, which will be a proxy for higher timeframe value migration.

'Current Value' is being defined as the average of intraday VWAP and the close of each 30-min bar. This will smooth out the calculation of ‘current value’.

The moving average is a 40-period simple moving average of just the closes of the 30-min bars and therefore is representative of the last few days average value.

Note how an auction changes directions, accelerates, then deccelerates and the moving average 'catches up' to current day 'value'. This signals that the auction is aging --- but not necessarily over. A gap or a tail will usually occur to signal the end of one auction and the beginning of another.


note: the current auction trend is still up. why? because Fridays 'value placement' is still well above recent days of value (as seen in the moving average). the market did not elongate to the upside on Friday but the overall structure is still generally constructive. a move lower on monday could be thought of as potential opportunity to buy in a constructive larger auction at a price below recent value.

[thrunner]

Congratulations Frank. You have achieved a first. The only Google search result for "auction trend" and "market profile" yielded this one and only URL: http://www.google.com/search?hl=en&r...ket+profile%22
which is this thread.

What is auction trend? aside from your current description of 'value placement'? Is it Market Profile based? Could you share a more specific description of your indicator? Thanks.