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Market Profile ®
Market Profile, developed by the Chicago Board of Trade and J. Peter
Steidlmayer in 1982, combines price, volume, and time data into a statistical
histogram, with distribution represented by a vertical bell curve. Used in
conjunction with other forms of technical analysis it can be a powerful tool
creating a balance between trend following, trend reversal, and stop
placement.

Steidlmayer, while working the open outcry pits at the CBOT®, noticed that
when the pit was quiet prices ebbed and flowed as buy and sell orders were
executed. He deduced that prices were in balance when this occurred, and
short-term players – in those days locals but today more likely the very short
term orientated “flippers” in the trading arcades - dominated that volume. It is
evident that short-term players dominated volume most of the time by
examining the daily volume of a market and the change in open interest. For
example, Daily volumes can be very large amounting to more than 1 million
contracts of volume on a daily basis but with an insignificant change in open
interest amounting to a few tens of thousands

The majority of short-term players are bound by time - they must exit their
position by the end of the day. Steidlmayer's established three elements:
Price + Time = Market Acceptance = Volume = Market Value
Steidlmayer also observed that there were times when volume was high
and the market moved directionally in a distribution and trended. As prices
were pushed in one direction, short-term players would often follow that
direction, or if caught on the other side, reverse their positions. He concluded
that it was long-term players who decided the current value was unfair and
pushed the market up or down mainly through initiating activity. Steidlmayer
also concluded that the trend ended when long term players determined
prices had trended too far and were under-valued or over-valued and entered
the market through response activity.
MP breaks down this activity and enables one to identify the short term from
the long term participants.

MP splits the trading day into 30-minute periods from the opening. Each
period is called a Time Price Opportunity. MP associates a letter to each time
period as placeholders for TPOs. Every time the market trades at a price that
has not occurred in a previous 30-minute period, a letter is placed at that price.
As the day progresses, letters build on each other to produce a view of prices
traded in the most or least time frames. In order to break down market activity
further, Steidlmayer created other tools.
A line to the left of the profile represents Initial Balance.
Traditionally, this refers to the first hour of trading. Steidlmayer reckoned that
when a market opens, prices move up and down and eventually find a
balance where buyers and sellers are willing to trade. When the market opens
within the range of the previous day, short-term players usually dominate
activity. If the market gaps higher or lower away from the previous close, it is
possible that longer-term players may enter and continue in the direction of
the gap (initiative), or view prices as unfair and move against the gap
(responsive). This tactic is crucial to understanding the relationship of the
previous day's close to today's opening, for example, when economic reports
occur within the initial balance period, long term players can be forced into
becoming short term players, which causes increased volume and volatility.

The line to the right of the profile represents the Value Area. This is the range
of 70 percent of the day's volume, either as tic or actual volume. Through
observation I have found there is a 95% correlation. So, while actual volume is
better, a tic histogram in place of a volume histogram can be used. The Value
Area is deemed to be what was fair value for the majority of participants.

MP is an essential tool for trading all products. It has applications in trading
the short end 3 month Euro$ where most intraday momentum analysis yield
poor results.

Various aspects of MP should be analyzed to determine which strategies to
use. It is often possible to eliminate one side of the market, unless something
very unusual occurs during the trading day, to make short term trading easier.
Because MP is frequently used as a day trading tool, it is unusual to analyze
further than five days back - many short term traders cannot remember price
action beyond that point. An exception to this rule is when price has rejected
value, typically in a single letter time
frame, i.e. a spike lower or higher. Lastly, no matter what product you apply
MP to or even what time horizon, MP is an invaluable tool for identifying areas
for the placement of stops.

FAQs
What Significance is there ……?

Q: If the opening is higher or lower than the previous close?
A: If the opening price is higher or lower than the close it signals a change in
sentiment overnight. The greater the difference in price the more significant
the change.

Q: If the opening is higher or lower than the previous day's value area?
A: This is more significant because what was considered fair value yesterday
is no longer considered fair value today. It's important especially if the price
has previously been balanced, E.G. price has been in a narrow range and
moving sideways.
Q: If opening price match, exceeds, or fails to meet the opening call level?
(This still has a bearing although with the advent of 24 hour electronic markets
less so where the overnight session highs and lows have taken on greater
significance)
A: It's important to get the opening call so you know exactly how bullish or
bearish the opening was, i.e., price has opened 10 tics higher than
yesterday's value area, but was due to open 20 tics higher. The opening can
be regarded as a failure on the upside if price never reaches 20 tics higher in
the first time period. (and so one needs to be aware of the O/N High and Low
to consider the same question and deduce the answer)

Q: If yesterday's close was at one extreme of the day's range?
A: The current day's opening determines if the previous extreme close was
caused by short term traders forced to liquidate or by long-term traders
entering the market. If the opening is higher, and the initial balance remains
higher, this confirms the close and we can expect a trend-up day. If the price
breaks above the initial balance, or support is found when the price returns to
the previous day's high or value area high, this indicates an uptrend. If the
open is lower than the previous close, this suggests a potential for price
reversal.

Q: If yesterday's close was within its value area?
A: This suggests the market ended with the day balanced. It's important to
see if there were any spikes or rejections of value as these might point the
way to the next trend.

Q: Re: the highest level of volume?
A: This provides a reference area of support or resistance, an important
consideration when placing stops.

Q: Re: the control point?
A: The control point is the highest volume of trade at a price, or prices, in a
close range. The control point indicates fair value and aids in placing stops.

Q: And are there any zones of support and resistance on the previous day's
extremes of value areas?
A: Value Area highs and lows prevent poor stop placements, but also provide
low risk entry points against the short-term trend. These trades work
especially well in broad sideways markets, but can also be used as profit
taking points.
The following FAQs apply to the first hour after the market opens.
What Significance is there ……?

Q: If the Initial Balance Range is much smaller than normal?
A: If smaller, it is highly likely that price will break out in one direction or
another, or possibly both directions. Typically, in the absence of any news
event that may drive a price, a breakout is not regarded as a directional move.

Q: If the first series of letters or TPOs created an excess that has not been
touched by the second letter?
A: This suggests the opening was regarded as unfair value and often
precedes a directional trend move. It's crucial to know the opening trading
range.

Q: If yesterday was a trend day, a balanced day, or a neutral day?
A: Balanced days, where the open is near the close, have similar properties to
Japanese Candlestick Dojis, and indicate potential turning points. A neutral
day occurs when price distributes in one direction outside the initial balance,
then reverses and distributes in the other direction. This is often caused by
news events. Generally, short-term traders are caught on the wrong side and
the reverse can often be swift and violent. Neutral days indicate nervousness
and a possible change in trend and can be compared to key, hook reversals,
as well as Japanese Candlesticks engulfing patterns.




Disclaimer:
While all attempts to ensure the accuracy of this data by using sources believed to be reliable.
This data shall not be construed as a recommendation to buy or sell any security.
TradingClinic™ and ALT Capital Management LLC® together with all associated companies
shall not assume any legal liability or responsibility for any incorrect, misleading or altered
information contained herein.

Please read the wider disclaimer posted on http://www.tradingclinic.com/disclaimer.php and
which is the basis for your downloading this document, displaying this document via any
viewing media and browsing this Website

				
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posted:10/3/2011
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