In my post about three things to focus on each day in the market, one of the things I mention is especially relevant to this issue of adapting to market behavior. What is happening at each price level in the market? In other words, it's not enough to simply know who is in the market and what they are doing. We also benefit from knowing the prices at which traders are aggressively buying or selling.
How can be do this?
One tremendously valuable tool is Market Profile, where we can visualize the amount of volume traded at each price level through the day. This tells us where the market is establishing value and how trader activity builds or dries up as we depart from value areas. That is great information as we make sense of whether moves away from value are likely to continue (momentum) or die out (revert).
Above, I've drawn a different kind of chart to illustrate how we can assess what is going on at various price levels in the market. The blue line represents the ES market during NY market hours on May 7th. Note that time is not on the X-axis. Rather, we're looking at the market in one-minute intervals from the lowest price registered during the day's session to the highest price. The red lines are the average high-low-close levels for the one-minute level of upticks versus downticks for all stocks.
So what we're seeing is the net buying pressure (upticking) versus selling pressure (downticking) at each price level touched during the day. What we can see is that for most price levels and through most the day we saw net buying interest. There was not a very high level of buying pressure (readings above +500), but there was very little net selling pressure. When we retreated late in the day and touched the day's lows, however, this occurred with solid selling pressure, with readings below -500.
That provides useful context for the coming day's session. If we should move higher, I will look to see if buying levels increase from what we saw the day before. If we test the day's lows, I will look to see if selling pressure is increasing or drying up relative to day previous levels. In other words, I'm looking to see if new buyers or sellers are entering the market and, at each price, I have a reference point to tell me how much buying/selling is additional and how much falls short of previous day's levels.
As I am writing this during the premarket session the next day, we have dipped below yesterday's lows. Should we continue at or near those lows, I will be looking carefully minute by minute for uptick/downtick readings to see if the fresh weakness is attracting selling. I will also be looking carefully at each minute's volume relative to yesterday (and relative to typical volume for that minute) to determine if participation is increasing or decreasing.
The big takeaway is that trading psychology is not only about *our* psychology. We can read the unfolding psychology of the marketplace by assessing the minute to minute behavior of market participants.
Further Reading: Who Is Controlling The Market?
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