FuturesTechs Blog

We appear to have piqued the interest of a few of you this week by adding the Market Profile charts to our reports. Market Profile is a charting method owned and copyrighted by the CME Group and developed in the 1980s by a chap called Peter Steidlmayer.

Steidlmayer was a trader in the Grains Pits and realised that the market was an ordered “auction” process made up of a number of different players, all of whom had various levels of interest in the short or long term direction of the market. The “Locals” like himself weren’t too bothered by long term moves and merely traded “in and out” over the course of the day. It was the “Commercials” or long term players such as Banks, Funds and (in the case of commodities) End Users, who had an interest in moving markets, and keeping these moves going in their favour!

Market Profile attempts to track this auction process on a daily basis to discover which group is running the market at any moment, and therefore whether price moves are likely to be sustained or reacted against with opposite trade. It is a popular tool with day traders in Chicago, and increasingly well utilised by London’s Prop trading community.

We have long used Market Profile as an additional tool to our daily, weekly and intra-day Candlestick analysis, but have steered away from talking about it for the sake of keeping the reports simple.

Now let’s look at a Profile and some of the terminology:

The Profile (see the graphic below) is made up of a series of letters, each letter representing a half an hour period over the course of the day. Instead of spreading across the chart from left to right like a traditional (30 minute) Bar or Candle chart the letters, known as “TPOs” are pushed as far to the left hand side as they will go, and this produces a distribution curve, effectively showing what price most trade has gone through at.

The longest line of letters closest to the centre of the day’s range is known as the “Point of Control” (D on the chart below) and is, effectively, the “mean” average price, sometimes known as the volume node.

If you move 1 standard deviation either side of this price you get the “Value Area”, so we’re not just talking about a price at that the market gravitated towards, but a “comfort zone” for price. Traders watch the previous day’s value area extremes (C and E on the chart below) carefully and this is one of the reasons we are now going to post the previous day’s Market Profile in our reports.

This means there are three more levels (on top of the previous day’s high, low and close) that active day traders will watch out for.

Another thing to watch for on Profile charts is occurrences of “Single Prints”. The chart below shows a “Single Print vacuum” in yesterday’s “K” period, when the market spiked higher and sustained the bid. This gave us support at 111.58 today in the Feb ‘12 Brent Crude, and as it turned out we spent very little time below here before rallying smartly.

The market tried unsuccessfully to “raid” yesterday’s Value Area, but this was rejected and we “accepted” the new higher valuation.

We did write a Blog about this a few years back. Here is the link:  

http://www.futurestechs.co.uk/blog/2010/01/06/technical-analysis-tutorial-market-profile-1/

We will also expand upon our interpretation of the Market Profile in our daily reports from now on, as we have the charts to illustrate what the heck we’re on about!

In the meantime please do drop us an e-mail if you have any questions (if you’re a client, of course!!).

FuturesTechs has delivered seminars for 7 City Learning for many years, and their latest public course is on October 14th 2010.

This is a full days training with FuturesTechs’ Director Clive Lambert, introducing a wide range of Technical Analysis methods on a 1 day course at 7 City’s HQ in the City of London.

The day will give the delegate an overview of the Technical approach, different chart types (Candlestick charts in particular), support and resistance, chart patterns, gaps, Fibonacci analysis, Moving Averages, Momentum Indicators, and Market Profile.

A free copy of Clive’s book “Candlestick Charts” is included, as well as full colour course notes.

Please Click here for further details, and to book your place.

Market Profile (c) is a distinct way of charting and analysing price action. It has a very different feel to normal methods of charting, so be prepared to look at markets in a very different way after reading this tutorial! Hopefully you’ll see why there are so many traders who swear by it.

Let’s jump straight in and have a look at one of these creatures:

The above represents a single day’s trading in FTSE futures. It could equally be represented by 30-minute candlesticks like this:

So what’s going on here?

Each letter corresponds to a 30-minute period. “m” is 8:00-8:30, “n” is 8:30-9:00, etc. The m’s are drawn in each price interval where this contract traded during the first half hour of trading, the n’s for the second half hour, etc.

Each letter is called a Time Price Opportunity (TPO). These form the building blocks of Market Profile.

Looking at the FTSE Profile above, we can see that the letters are sat next to each other from left to right, forming a “heap” . Where the price bulges out the most tells us where the price traded in the most time intervals, giving a sense of “value” for the day.

With that said, let’s introduce some more terminology.

Initial Balance Period (IBP): this is the range of the first hour’s trading. In the FTSE, then, it is represented by the price range covered by the m’s and n’s. CQG draws a blue line to the left of the Profile to highlight this, and we’ll put it in bold below:

The IBP is often important, depending on which market you’re trading, since volatility on the open can sometimes bring about a “Comfort Zone” within which people will trade with a sense of safety for the rest of the day. Breaking out of the IBP then, is something that Profile watchers will keep an eye on.

Point of Control (POC): This is the price region with the most TPO’s, i.e. which has been traded during the most time periods. If there is a tie for which price has the most TPO’s then we choose the one closest to the middle of the day’s range.

In the above Profile, we see that 5220 and 5190 both have eight TPO’s. But 5190 is closest to the centre of the range, so it is the Point of Control.

This is a useful price because it tells us quite precisely where the market traded most frequently. Above there could be considered poor value for the day, while below there could be considered good value for the day.

This notion of “value” is expanded with the concept of the Value Area. This is the price range containing 70% of the TPO’s, split evenly around the Point of Control. (The reasoning behind this is that in the “Normal” distribution, around 70% of observations are contained within one standard deviation of the mean.)

This gives us a wider range of value for the day. This range can then be overlaid onto a candle or bar chart; we can use it to provide suggestions for support and resistance levels, or just to see how the market’s perception of value is evolving. Here’s an example:

In the above chart, we have the folowing key:

Green: High of Value Area

Blue: Point of Control

Brown: Low of Value Area

That completes our discussion of Profile construction. Now let’s consider some of the ways to intepret what’s happening (this will involve some extra terminology!)

Initiative and Responsive Price Action: we can classifying buying and selling as “Initiative” or “Responsive” depending on whether it takes place above or below the previous day’s value area.

So if the price is expanding above the previous day’s value area, then we can call that “Initiative” buying. And if those gains are being sold back down, that selling can be described as “responsive”.

Similary, selling down below the previous day’s value area is called “initiative” selling. As you might guess, gains back through those levels would be called “responsive” buying.

Much of the philosophy behind Market Profile is to do with the fact that different types of market participant move the market in different ways. On the one hand, there are “liquidity providers”, the local or proprietary traders, who profit by making small gains on lots of trades every day.  Their purpose is to facilitate the actions of the institutional traders.

The institutions are the ones who, thanks to their size, are truly capable of moving markets. In the context of  commodity futures, these would be the commercial hedgers.

For example, the below chart shows a market which was fairly stable on the first day, and then made a big shift on the second:

Without looking at the volume figures, we could surmise that much of the action in the first day took place with traders and a relatively small number of evenly matched institutions. The second day, though, took us out of that day’s range, with the gains being accepted by the market. That makes it Initiative Buying, and we can surmise that it was institutional demand which created it.

Single Print Tails: time periods with just a single TPO, mostly at the extremes of the Profile.

In the above Profile, we can see that this market had two such tails: for period “D” at 5300, and period “E” at 5440. The price moved into those regions, but the move was rejected. The move back from 5300 is probably “responsive buying”, while the move back from 5440 is probably “responsive selling”.

In the next article on this topic, we’ll categorise different types of trading day according to their Market Profile. There’s lots more to be covered here, so stay tuned!

Graham Neary MSTA (graham@futurestechs.co.uk)