Friday, July 25, 2008

Distinguishing Trend Days From Range Bound Days

If you click on the Market Delta chart above, you'll get a unique view of today's action in the S&P 500 emini futures market.

The histogram at left shows the total volume transacted at each price traded during the day, with the volume divided by the amount transacted at the market offer price (green) and the amount transacted at the market bid price (red). The numbers to the immediate right of price on the left vertical axis represent the difference between volume transacted at offer and bid at each price point.

What you can see is that it is a very mixed picture, with only 9803 more contracts transacted at the market offer than bid over the course of the entire session. Some prices show more volume at offer than bid; other prices display more volume at bid than offer. This relatively even distribution of volume across bid and offer is typical of range bound trading sessions. The quicker a trader can recognize this evenness, the more able he or she is to fade moves at range extremes rather than get caught chasing breakout moves that never materialize.

A second clue of the range bound day is the shape of the volume histogram at right: a shape we recognize from Market Profile theory. Note how the shape forms a relatively normal distribution, with the majority of volume transacted at the center and far less at the price extremes. That tells us that higher and lower prices were not attracting participation. This drying up of volume away from the central, value area is what keeps markets in trading ranges.

Also observe the half-hourly distributions of volume. These show how volume traded at the market offer vs. bid for each half-hour during the trading day, with the "point of control"--the price at which greatest volume was transacted--outlined. We can see that there is no trend to these half-hourly points of control. Indeed, the inability of the market to move value above the 1260 area early in the day provided a nice fade trade toward the other end of the range.

Finally, note the volume histogram bars at the lower horizontal axis. These also are color coded based upon whether more volume during the period was transacted at the market offer (green) or bid (red). We can see how volume dwindled through much of the day, particularly during the periods in which the market tested range extremes. This failure to attract participation during the day is also characteristic of range markets.

Thursday gave us a great trending market; Friday gave us a trading range. In a trending market, you'll play ranges for breakouts in the direction of the trend. In a range market, you'll tend to fade breakout attempts. One mode assumes continuation; the other reversal. Making the read of trending market or range market early in the day can make all the difference in trading success. Observing unfolding price and volume distributions can provide useful clues in making that call.


Mr Trade said...

truly revealing chart!

Sean said...

I am in biotech industry. I deal with Std Deviations and coeffient variations everday. As any astute student would say, 20/20 is always hindsight. Can you give us some clues (via data) that would tell us within an hour or so that a non trend day is upon us?

Globetrader said...

Hi Brett,

in my experience these price/volume histograms can be misleading, which is the reason I removed them from my charts again.

Of course everything can be misleading, still looking at your chart during the 9:30 period one would assume a continuation of the upmove given the strong buying taking place. If you had followed the DAX and FTSE indices at the same time you would have seen these indices going up 25 points in that period (which is 50 ticks or approximately 1000$ per contract traded for the DAX). ES managed 7 ticks in that same time with high volume traded.

What this chart is really telling us is, that there are very big offers which the market is not able to take out. These offers are not aggressively traded, they sit in the market, are continuously refreshed and wait to be taken out.
Despite all the buying volume you see in that 9:30 period the market is not able to get through these offers.
The market backs off and tries again and again. An intraday triple top is made with lower highs in the 10:00 and 10:30 period and finally the market sells off.
Now (most likely) the same volume sits at the bid and again waits to be taken out. Look at the volume traded at the 1253-1252 levels. The market tried hard to break that level to the downside in the 13:00 period, but is unable to do so, as big volume is sitting there. Not aggressively buying, just sitting there and waiting for the market to come to it.
It reminds me of a spider which is playing the market like a real expert.

Price/Volume histograms tell you what the market is trying to do, but they don't reveal the silent counter traders. They don't show these huge orders at the ranges of the market, which take a lot of volume to work through.

Nowadays these orders are not traded at a specific level, they are placed in a range. So the market might work through one level only to find the same resistance again one or two ticks higher. You can't possibly know when these orders give way and the only way to trade them in a any type market (at least the only way I know of for a small private trader like me) is by being already in the market when we come up or down to such levels.

Never Sell a low,
Never buy a high.

You either be already in the market and in a profitable trade or you have no business to trade for that possible break. The risk/reward of these trades is just horrible.
Best regards,


Mr Trade said...

Dear Brett, Could you please post a follow up showing what this chart looked like on a steady uptrending day and on a downtrending day. Thanks!

Trevor said...

Like any form of pattern recognition, reading these types of charts with acuity can take time and will develop with experience.

Responding to Globetrader, when you see large buying or large selling at extremes you are obviously correct to assume there is an opposite side to the trade. The aggressive buying you saw at 9:30 (green) was met with supply. These are the passive (resting) orders you mentioned. Despite the order flow (buyers trading into the resting offers) being to the buy side, there was supply there to "soak" up the demand.
Of course, price could have advanced but at least you would know 2 things. One, there was decent volume at this level which may provide support on a pullback, and secondly, if price does go higher, there are a large amount of shorts that could provide fuel for a breakout move higher.

Some of my observations have been markets that are prone to rotating back and forth (intraday) will exhibit large volume at price extremes as the masses play for a breakout and the smart money happily takes the other side of the trade without having to be aggressive in nature to get their trades off.

IMHO, this is one of the primary benefits the volume distribution can provide traders.

Brett Steenbarger, Ph.D. said...

Hi Sean,

The main clues I use are relative volume (how the current volume compares with the X day moving average) and the distribution of the NYSE TICK.


Lover Dad said...

Any way to foretell the extreme run in the last 5-10 minutes of the day, other than to use the force?

Brett Steenbarger, Ph.D. said...

Hi Lover Dad,

The prop traders I work with identify the move early by tracking volume at price patterns; they don't "foretell" it.