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.