Markets in Profile

A. Change is universal (even in markets)

1. Innovators → early adopters → early majority → late majority → laggards
2. Time periods are fractal. Book will start with longest

B. Market-generated info is pure and unbiased

1. Use CBOT Market Profile to see structure in real time. for example:
1. symmetrical bell shaped profile usually means balance between good and bad opportunities
2. asymmetric Market profile means asymmetric opportunities (risk vs reward) due to imbalance
3. Goal is to look for number 2, where reward greatly outweighs risk
2. imbalances away from "fair value" caused by human emotion and behavior
1. essentially a mean reverting strategy then

A. Fundamental information can be right...

1. ..And still fail to predict prices
2. This is due to different contexts (expectations)

B. Momentum Investing is rational

1. Consider betting on a horse race as it's occurring
2. Much statistical evidence supporting

C. Market Generated Information combined with fundamental information is the most powerful

1. Actual flow of orders in the market's present day context
2. Markets always moving from low to high and high to low (two way auction process)
1. collectively the result represents fair values
3. Use CBOT Market Profile for analyzing this

D. The Auctions: Price, Time and Volume

1. Price advertises opportunity, time regulates it and volumes measures success
2. This process results in fair value, not all prices are equal (same volume).

E. Fair Values: Price Levels that attract the most volume

1. Different relevance for different time frames: fair in the "day timeframe" could be considered unfair longer term
2. Histogram (distribution curve) used to illustrate
3. Reversion to the mean: Sometimes, buyers (sellers) get discouraged with prices above (below) fair value. This creates a fair value range and any movement outside will decrease volume until new equilibrium is found
4. Other times, divergences above or below range attract MORE volume, forcing participants to re-asses value (reversion to mean stops being profitable)
5. When you can distinguish between these two times, you can structure high reward low risk trades

F. Market Profile Fundamentals

1. Price on Y axis. numbers or letters for each time period stack up to create volume (accumulation of prices)
2. A bracketing or sideways market (longer term) will have many overlapping day ranges.
3. Trending markets have much less tendency to overlap.
4. The big choice for traders: is the market sideways or trending?
5. Value Area == Point of Control (POC): contains 70% of all Time Period Letters (1 SD)
1. Start at most volume. Compare 2 lines up and 2 lines down. Whichever highest include value area. Iterate 2 above/below of new value area until 70% encompassed

G. Demystify the Market: What's the Goal

1. Market Profile captures the structure of the market as it unfolds. That's it. Cannot tell you when transition will happen between trending and bracketing markets.
2. Using different time frames for context increases odds of successful trades
3. Different strategies cruciual for different markets (trending vs bracketing)
4. Timing the transitions is more about picking spots (risk/reward).

A. Importance

1. All Transactions, it's true, have a buyer and a seller. The difference is their time frame
2. Think of housing market: investors, both long and short term, permanent residences, etc.
3. Or GM and dealerships. When inventory gets stockpiled at dealers, they go from short term buy/sell balance to only sellers, driving price down for long term buyers

B. Breaking Down Market Time Frames

1. Scalper: Operate in minutes, exchange traders, rely on intuition, interact with all other time frame participant and provide liquidity
2. Day Trader: goes home with no position, use news + order flow + technicals, the Fed, love tchnical info, numbers and levels and hype
3. Short-Term Traders: not longer than 3-5 days. not as much news driven, insead attempt to buy the lows and sell he highs + watch for breakouts. Use momentum, trend lines
4. Intermediate Traders/Investors: "swing traders", months, think markets are like pendulums. Go by size of move not time horizon.
5. Long Term Investors: Years, fundamentally driven, married to positions. LT Investors break new ground, start trends, upset status quo when they move

C. Timeframe is the Strategy Cornerstone

1. Identify which timeframe is in control of market activity
2. Identify which timeframe suits your personality best

A. Three Elements

1. Price: volatile variable and fasted moving market element
2. Time: constant around which all data organized
3. Volume: also variable, but moves much more gradually than price. Represents interaction of time and price.

B. The Search for Value

1. Markets generally find balance, deviations are accompanied with lower volumes. These make good entries to buy/sell when price is below/above the POC on light volume
2. Sometimes in trending market, higher (lower) prices beget more volume, not less, moving the POC higher (lower). On those days the buyer (seller) can transact above (below) perceived value at the time and still end up fine.
3. A correction can occur without lower prices: long term buyers transact with short term sellers (profit takers). Market in balance at value without price lower
4. Follow value, not price. Higher prices + higher volume = higher value but may close with low volume and value at lows...causing you to miss a bullish signal

A. Compound Auction Process

1. Unlike an art auction market auction process is compound, as soon as one ends another begins.
1. have to identify over which timeframe current auction is taking place on. m
2. Recognizing where you are in the auction process determines your risk/reward relationship

B. The Ebb and Flow of Balance

1. Markets don't transition directly from bull to bear. They go from trending to bracketing, before deciding to countertrend or continue same trend.
2. Balanced or bracketed markets on long time frame can last months, often don't recognize until well underway

C. Where do trends end and brackets begin?

1. Not a science...
2. Auctions that occur near bracket extremes provide significant information about the odds of a breakout
1. High volume, odds good movement will continue
2. Low volume = buyers have disappeared, sellers are not getting filled. likely to reverse
3. It all hinges on balance vs imbalance: Declining volume signals a need to balance

D. Clarity in the Maelstrom

1. Need to look at long term and weekly charts for the big picture and remain objective. Don't have to be Market Profiles.
2. Once a price moves a long term balance area, even though it may have traded in range for months, prices can move extremely quickly coming out, at least initially
3. Market Profile shows you change, it is displayed in the present tense. Entirely liquidity driven

E. The Big Picture

1. Prices are not efficient they are effective (have to go too high for auction to realize price is too high (lack of volume))
2. Price is an advertising mechanism for attracting volume
3. Prices cannot be forecasted, that is the entire point of having the auction. That does not mean no way to make money.
4. Prices are always "fair" on the shortest of time frames, but could present opportunities on longer time frames
5. On a given time frame, all prices, and therefore, not all opportunities are equal. Seek out imbalanced, asymmetric situations with high risk and low reward.
6. Always be aware of higher up time frames so you aren't fighting them unnecessarily.
7. Long term need to be aware of short term at turning points

A. Convergence and the Bracketing Process

1. Convergence = transition from bracket to trend, or trend to bracket. Leads to volatility
2. Difference between bracketing and bracketed market subtle difference (hindsight is 20/20)

B. Defining the Intermediate Term

1. Distance traveled not length of time that determines term. Intermediate term generally encompasses highs and lows of shorter timeframes.

C. The Transition from Bracket to Trend

1. Often a much tighter range at one extreme of the bracket is signal of impending transition to trend
2. Greater the bracket, bigger the potential move (more timeframes involved)
3. A bracketed market is in balance, waiting for news. Eco numbers will have a greater effect in a sideways market vs a trend

D. The Transition from Trend to Bracket

1. Can end on drying up of volume, exhaustion
2. Can end on excessive hi/low where prices immediately rejected and reversed
3. Most common is both
4. End of trend “capitulation” thought to be high volume but usually other way around. low volume that gets rejected downwardly by high volume

E. The Convergence of Intellect and Emotion

1. End of an auction represents the most opportunity
2. Imagine a tick chart bear auction where price has moved down consistently then the trend reversal looks elongated (bar) but on low volume. If you keep your head and see the low volume and excess pc to downside you can call a reversal
3. Get this right and you have low risk (easy stop) and high reward

F. Accelerate the Learning Process

1. Incredible amount of effort to go from competent to excelling at trading
2. Balance short and long term auction analysis to accelerate your learning

G. Prelude to a Sea Change

1. Don’t forecast, only asses risk and put self in low risk high reward positions
2. Trending markets balance, breakout, balance, etc. Stronger trends more time between brackets.
3. Generally speaking, trending markets are longer term than bracketing markets (brackets as pauses during trends

A. Analyzing Short Term Markets

1. Need previous days trading activity to get a sense of how to trade
2. Trending? Bracketing?
3. How big was the fair value area before? Wider is better, more agreement on value
4. There is a difference between odds and good risk/reward. Odds of higher may be greater, but if at high end of bracket, still make sense to short with a tight stop

B. Good Short Term Opportunites

1. Short term opps often come at the extreme ends of brackets
2. Good trades are often contrarian, fading extreme of a balance area seeing low volume. Requires mental toughness

C. Confidence of Market. Watch:

1. Attempted direction
2. Volume
3. Value area placement...overlapping, overlapping a little, higher, lower
4. Shape: symmetrical =balance, elongated = trend, squat = balance + exhaustion of trend
5. Short covering often ends in “p” shape (buyers not enough conviction to elongate)
6. Long liquidation often ends in “b” shape (sellers not willing to press)

D. Look for change

1. Often a trend is being exhausted when you see distribution become squatter
2. Even when price is unched or lower, value area may be higher
3. A good short term day trade in direction of auction may be good but poor trade placement for the medium term !
4. Ask what are competitors doing? Who is late to the party? what’s is MKTP saying that’s different than sentiment?
5. Fade Extremes, go with breakouts
6. Go with moves coming out of balance

A. Correction of Inventory Imbalances

1. Excess marks the end of one auction and beginning of another in the opposite direction
2. If you cant get this "excess" with a sharp reversal, market may be too over positioned in that direction
3. long term short covering is a recurring pattern - these are very difficult times to go long even tho "right" trade

B. Market Condition

1. Trend or bracketing market?
2. If trend, young, aging or old? The more distance between balance areas the younger the trend
3. If bracketing, can visually see where we are

C. The Market is Open

1. Once market opens, key questions are what direction and how successful?
2. Four types of openings:
1. Open-Drive: strongest, most definitive. opens and auctions aggressively in one direction
2. Open-Test-Drive: opens outside of a range in one direction, testing, before quickly reversing
3. Open Rejection Reverse: like number 2 but slower moving, more time before the rejection
4. Open auction: no clear direciton on open