Monday, January 02, 2006

Using Market Delta in Trading

I've received a number of emails regarding the use of the Market Delta program in trading, so I decided to post here rather than answer the same questions separately.

For those not familiar with MD, it displays price in a bar chart but within the bar captures volume information. This includes total volume at each time and price and a division of the volume in terms of the number of contracts (or shares) traded at the bid price vs. the number traded at the offer. The chart above is taken from Market Delta; I have annotated it to show areas where you can see buying dry up and selling picking up. This is very helpful information for short-term traders.

The key is looking at the bars horizontally as well as vertically. When there's buying, for instance (buyers eager to get into the market and lifting offers), you can see increasing volume with higher price when you look vertically. You can also see increasing volume at each price relative to the previous bar when you look horizontally. Markets that are facilitating trade will show increasing horizontal and vertical volume. It's when volume peters out, both horizontally and vertically, that you start to look for short-term reversals.

When you combine the information from MD with the Market Profile, you can gain a very good understanding of the day's auction dynamics. You'll see volume pick up at range extremes prior to breakouts, and you'll see volume die out prior to mean reversions. Many good trade ideas can be developed from this combination of sources.

Another use for MD is looking at occasions when large traders are entering the market and seeing whether their big trades are predominantly at the bid or offer. Large traders will control market direction in the short-run; knowing whether they're leaning long or short is very useful information. Setting MD to a 1 tick reversal bar will basically show you every trade coming into the market and whether it's at bid or offer. Or you can just watch the shifts of volume within longer-term bars to see size coming in.

This article I wrote a while back explains why I think information re: large traders is important.

Several people have asked me about settings for bar coloration in MD. It's not crucial; just create a setting that gives you the darkest color (indicating highest selling or buying volumes) about a third of the time. That way, you'll know that volume is about 1 standard deviation above normal when you see the dark colors. Otherwise, color is much less important than the shifts of the numbers, vertically and horizontally.

Please note that I do not have a proprietary interest in MD, Market Profile, or any other programs I mention on my sites. I do keep my eyes open for unique implementations of trading software and try to bring this to readers' attention from time to time. Later this week I hope to talk with the founder of Ninja Trader and pass along some impressions of that program.

Hope this is helpful.