Monday, February 12, 2007

Market Profile: A Best Practice in Trading

My recent posts have emphasized the importance of tracking the large traders in the market you're trading. Such tracking will help you identify when we are making breakout moves and when we are trading within bracketed ranges.

Market Profile is a tool for organizing time and price data, graphically representing how volume builds at various prices over time. When we see most trades occurring within a relatively narrow range of prices, we know that the market is in balance. Price will probe the edges of this balance area--called the value area--as markets constantly update their estimates of value. If prices higher or lower than value cannot facilitate trade (i.e., if higher prices don't attract buyers or lower prices don't attract sellers), we will tend to trade back into the value area. If these probes to the edges of the value region do facilitate expanded trade, we will break free of the value area in a trending move. That trend will continue until sufficient sellers or buyers perceive value in the new prices and take the other side of the trade, beginning the process of forming a new region of balance.

My specific best practice is to be aware of value areas at one level larger than the timeframe you are trading. Very often, a breakout at a shorter time frame occurs within the context of a longer-term market bracket. Knowing where value is located on the longer timeframe helps you identify price targets for the shorter-term move.

An excellent resource for understanding the dynamics of Market Profile at multiple timeframes is the new book Markets in Profile: Profiting from the Auction Process by James Dalton, Robert Dalton, and Eric Jones. It is not a lengthy book, but it is packed with trading principles and clear examples of how the Market Profile is relevant at various timeframes: from the daytrader to the longer-term investor. Dalton and colleagues explain how markets transition from brackets to trends and, more importantly, they help traders understand why. One of my favorite features is the graphics that help you see balance areas on bar charts. It enables you to see the market in profile even if you're not looking at a Market Profile.

If you are just getting started in the area of Market Profile, the authors' earlier book, Mind Over Markets, is a classic and a great introduction to understanding market auctions. You can also find excellent reading resources on Market Profile on the WINdoTRADEr website. WINdoTRADEr is a charting application that enables traders to see Market Profiles at different time frames simultaneously; the firm also offers hands-on training in the use of Market Profile and the software. It's a brilliantly designed piece of software (which, by the way, has benefited from input from Jim Dalton).

What makes Market Profile a best practice in my book is that it provides new and experienced traders with a way of thinking about market action and framing their trade ideas. If I were running a training program for traders, Market Profile would be a mandatory part of the curriculum. It's important to know, not just *what* to do, but *why* to do it.

10 comments:

yinTrader said...

Hi Brett

You hit the nail on the head - when you said you would make Market Profile mandatory if you were running a training course for traders.

I have resolved for 2007 to start reading up on Market Profile now that I am using MarketDelta which essentially is an offshoot of Market Profile to my mind.

You are absolutely right that it is suitable for both new and experienced traders, as I feel the need to know even though I am a novice trader.

BTW hope you take lots of VitC for your cold! Seems to be pandemic!

Brett Steenbarger, Ph.D. said...

Hi Yin,

Yes, I agree: the Market Delta and Market Profile frameworks are complementary and can be integrated nicely to develop trade ideas. Thanks for the observation--

Brett

Yaser Anwar, CSC (Trader- Equities & FX | Quoted 7 Times In WSJ, Twice in NYT & FT) said...

Sir-

Can you make any recommendations, books/courses whatever, that can teach one more about the volume?

I know trading is the best method, but given my school timings, I don't always get to trade. Over the past few weeks your volume analysis/dissection techniques have been extremely educating.

many thanks.

Brett Steenbarger, Ph.D. said...

Hi Yaser,

I do think that the Dalton book, Mind Over Markets, is an excellent starting book for understanding volume and the market auction process. His new book, Markets in Profile, builds on the first one, giving illustrations at different time frames. Those are the books I'd recommend to a new trader re: understanding how volume is distributed. Thanks--

Brett

Brandon Wilhite said...

Dr. Brett,

I'm hoping you can answer my simple question for me...I looked at Market Profile for at least an hour last night and didn't find it...I'm hoping you'll help me out so I don't have to waste 2-3 more hours tracking down the answer :)

Does Market Profile require volume information? It seems that it does. I trade retail spot forex, so if it requires volume, I'm not sure how helpful it might be to me unless I looked at the futures. Even then I'm not certain.

BW

Brett Steenbarger, Ph.D. said...

Hi Brandon,

Market Profile is licensed by the Chicago Board of Trade, so has to be purchased as an add-on through data vendors such as e-Signal. Because it is organizing price and time data and making inferences about volume from the accumulation of TPOs (time-price opportunities), it does not require volume and could be used with spot forex. There are implementations of Market Profile that add volume as an explicit consideration (WINdoTRADEr is one) and there I do think the currency futures are worth looking at. Market Delta has a Market Profile-like feature that shows cumulative volume at prices on the Y Axis over varying lookback periods, and again currency futures are worth tracking in that regard. Hope that's helpful; thanks for the question--

Brett

Jeff said...

those who are interested in Market Profile may want to check http://www.balancetrader.com.
I am not affiliated with this site, BTW.

Brett Steenbarger, Ph.D. said...

Thanks for passing along the link, Jeff. Also check out this site from Jim Dalton and Terry Liberman:

www.marketsinprofile.com

and from Tom Alexander:

www.alexandertrading.com

Brett

The Myth from harvard and sports handicapping picks lover said...

Dr. Brett I just made the market profile page for wikipedia and used traderfeed as one of the references. I hope that is okay. Also I would love to speak with you one day what would be the best way to get in touch?

-Rich
Charto911@gmail.com
http://en.wikipedia.org/wiki/Market_profile

Ali Mohseni said...

Hi Brett,
Thanks for sharing useful info. Your article about Market profile is very interesting.
I also wanted to introduce my own blog to you and ask you if you get a chance, please look at it and give me some feedback.

Thanks

Ali Mohseni