J. Dalton - Trading Articles

http://slidepdf.com/reader/full/j-dalton-trading-articles 1/376
PROTECTING YOURSELF FROM ME AND ALL OTHERS
Successful trading requires that you protect yourself from your own opinions, my opinions, if
you are reading our blog, the news services, and anyone else that you may be following. The
answer rests in employing marketgenerated information (MGI): listening to the market versus
those referred
to
above.
Quite
often
we
get
an
opinion
riveted
into
our
mind
only
to
see
the
market doing something entirely different; if you have advanced to the stage of understanding
and endorsing MGI yet are unable to act when you clearly see a different opinion expressed by
the MGI, you are experiencing cognitive dissonance, the psychological conflict resulting from
holding two simultaneous, conflicting thoughts. I never knew a trader who hasn’t constantly
had to deal with this issue; the emphasis is ongoing.
S&P 500 Dec 2010 as of Thursday, September 23, 2010 for PreMarket Friday:
Let’s make this real and very personal: on Thursday afternoon, Sept 23, 2010, when the S&Ps
couldn’t trade and stay above “unchanged”, 1129.60, which is always a day timeframe
reference, the market called for a day timeframe short. The market broke and settled below the
reference I had previously published (1122.00). But because the POC or fairest price to conduct
8/17/2019 J. Dalton - Trading Articles
2
business remained just slightly below unchanged and did not migrate lower with the price
break, the market also called for the day timeframe short to be covered.
Our Premarket blog post on Friday, September 24 th
stated that the NASDAQ rally didn’t look
complete to the upside while the S&P auction didn’t look completed on the downside; we
thought that the better odds for Friday’s S&Ps were for a balancing day.
S&P 500 Dec 2010 after Close on Friday, September 24, 2010:
As you can see, the market gapped 13 handles higher on the opening; the news stories
attributed Friday’s rally to the Durable Goods report. The rally was well under way prior to the
news report. The failure of the POC or fairest price to conduct business to migrate lower with
price on Thursday alerted us to the possibility of heavy short inventory positions, inventory that
was “short inthehole”, trader talk for short at bad prices. This is often a setup for a short
covering rally. The fairest price to conduct business (POC) on Thursday was substantially higher
than Thursday’s close; these late day shorts had very poor trade location—many traders were
caught short at poor prices.
3
On the other hand, since the settle was below my reference level at 1122.00, I thought the best
case to be made for Friday’s trade was to see the market balance; this was my final opinion to
be posted on our blog. Our post also said, “The upper focus is on the market’s ability to trade
above and maintain price and value above Thursday’s high; failure to accomplish this keeps the
pressure on the downside.” However, I didn’t pay this possible scenario enough respect.
On Friday morning, as you watched the overnight trade continue to creep higher with the
opening approaching, you should have been on high alert and prepared for, at least, a short
covering rally given the traders that got caught ‘short in the hole’ on Thursday’s late downside
break.
Thursday illustrates one of the more subtle pieces of marketgenerated information you will
deal with. Yet its subtlety also hides it from the majority of traders—an identifiable edge to
those traders who do pick up on it. I often say, nuances are important . Let’s discuss some of
these to understand the subtle marketgenerated information generated by Thursday’s auction.
Below is a split out Profile of the S&P on Thursday, September 23, 2010:
We observed eight auctions that stayed around unchanged. The auction did not find
acceptance above this day timeframe reference. An important part of trading is
4
recognizing who is dominating in the session: if longerterm money was buying on the
move up, the day timeframe reference of unchanged would have been taken out in a
shot. The auction rotating around the unchanged level indicated that day timeframe
traders were dominating.
Wednesday’s ‘b’ shaped Profile indicated liquidation—old business versus new money
selling. The
laggard
longs
that
had
not
liquidated
on
Wednesday
were
likely
getting
nervous late Thursday afternoon, as price was unable to probe higher.
Day timeframe longs that bought the upside move on Thursday morning were not
getting much for staying in their long positions either.
As the day wore on and the closing bell approached, these laggard longs and day
timeframe longs began to liquidate contributing to the late afternoon break that ended
with a close near the lows.
This emotional, rapid liquidation break also brought in emotional sellers (weak hands)
that got short at poor trade location, as we discussed above. This set up the possibility
for a short covering rally.
The pieces to the puzzle from Thursday’s auction required independent thinking and a focus on
marketgenerated information. Focusing on price late Thursday afternoon was very misleading.
Market Logic: Too often traders make decisions in a vacuum and fail to look at other markets or
potential influences. On Friday morning the Dollar Index was at new recent lows and opened
about 4 handles lower; this was likely seen as bullish by stock market traders. Whether there is
long term data to support this stock market reaction to lower Dollar Index prices is
questionable; nonetheless this is what we often see. We are not economists, we are traders.
The S&P’s (big contract) gapped higher and failed to back up and fill that gap; the markets said
we were

Friday. This certainly wasn’t what I expected; however, applying MGI allowed traders to get on
the trade.
S&P December 2010 Big Contract Open September 24, 2010:
Marketgenerated information telegraphed the rally once the market opened and couldn’t fill
the gap. Simple right? Yet this market situation on Friday illustrates (once again) the concept of cognitive dissonance. The big downside break on Thursday afternoon followed by an upside gap
opening of 13 handles required a huge mental shift in market perspective; a difficult task for
most. Yet the marketgenerated information was there to convey what was happening in the
auction.
STRUCTURE
2
We start this discussion with a bar chart and the Market Profile graphic side by side to compare a one
dimensional versus a two dimensional graphic.
In one dimension, the bar chart is not able to show the character of the market; where the majority of
business took place, at what prices levels, and for how long. The Profile graphic releases a substantial amount
of
information
to
inform
the
observer
of
the
complexity,
as
well
as
the
nuances,
of
the
auction
process.
MarketGenerated Information and Structure
The Market Profile® graphic is a time sensitive, evolving database that updates in realtime to reflect the
structure of the market’s natural twoway auction process. Marketgenerated information (MGI) is the
byproduct of the natural twoway auction process and it is conveyed through the Profile graphic.
Structure is revealed through the marketgenerated information and provides us a composite view. It is much
more than individual data points; it graphically conveys complex information that allows us to see timeframe
participation, inventory, completion (or lack thereof), emotional trading, as well as the nuances reflected over
various timeframe perspectives.
The Profile graphic equally conveys day timeframe structure to enable a trader to formulate a tactical plan
inside the day. Similar to the broader perspective, it allows a composite view, and in this light, may prove even
more helpful to protect a day timeframe trader from being mesmerized by price. Day timeframe information is
relevant to all traders when you consider that everyone is day timeframe trader the day they enter or exit the
market.
Our objective in this article is to discuss structure through various examples so that those interested to learn
more can get a feel for what structure conveys. It is not linear with several reference points listed on a sheet.
Because it is a composite, we can draw on the power of the human mind to see several data points in context
and get a sense for what is transpiring. After all, the market is where buyers and sellers come together to
engage in twosided trade; people, not numbers, transacting as the auction unfolds over the day, multiple
days, weeks, months, and years. Structure enables us to view confidence, emotion, strength, and weakness,
along with the more mechanical components, to understand the various participants and the virtually infinite
motivations that move the markets.
INTERNALIZING THE IMPORTANCE OF STRUCTURE—The best way to begin to appreciate the importance of
structure and how you can employ it is through example; let’s begin with day timeframe structure. In a future
educational article
Chart 1: Treasury bonds September 13, 2010
The Profile on the left represents a relatively strong, healthy day timeframe auction; on the right is the same
Profile with each 30 minute time period split out, which allows you a clearer perspective of how the day
developed.
You see from the expanded Profile that the market auctioned higher, balanced for five periods then departed
the balanced range to auction higher again, and then balance again into the close.
TREASURY BONDS
5
1. Our Profile on the left and the “Almost Perfect Day” Profile we showed to begin with have one
thing in common: they both record a market attempting to auction higher. We are always trying to
assess what a market is trying to accomplish followed by asking, “What grade would we assign to
the effort?” If we assigned a B+ to our 1 st Treasury bond example, the last example might receive a
gentleman’s C.

The fatness, reading from left to right, allows us to see how much time was spent at each price
level; the widest area represents the fairest price at which business was being conducted, or the
point of control (POC). The more prominent the point of control (POC) or fairest price at which
business was being conducted, the more volume it will likely require for the point of control to
migrate to another sustainable level.
6
2. The daily auction doesn’t look to be complete; when an auction is over, price should drop away
quickly. It spent three ½ hour periods here.
3. Review this profile; you should notice that it lacks any symmetry. This statement becomes clearer
as your experience with viewing Profiles expands. The lower portion has no symmetry with the
upper portion. Over time, the continual twoway auction process, very often, completes the
symmetry.
4. Just as we commented about the top of the S&P Sept 24 th
profile not appearing to be completed,
the same comment is now is applied to the S&P Sept 27 th
profile next to it.
5. The market has attempted to auction lower and selling has dried up; it is likely that the market has
gotten too short, in the day timeframe, to go any lower. The uncompleted previous high also
indicated that the market had gotten too long in the day timeframe to go any higher (these are
other concepts that you will explore as you continue your education). Often, markets have to
“break before they can rally” or “rally before they can break”; this is how inventory is adjusted.
6. The rally that begins in J period and terminates in L period completes the auction from the previous
day, much like a baseball game that was suspended because of rain. You will hear us refer to this as
“repair”. Now that there is a completion of the upward auction, our focus should return to the
uncompleted lower auction. Remember, markets are continually developing through a natural two
way auction process.
7. The downward auction is completed. Again, this would be considered “repair”.
Understanding the complex information visible through the market’s structure allows traders to begin to
migrate away from pricebased thinking and trading, to move to a more complete appreciation of the
continual twoway auction process and the continually unfolding opportunities. Remember, price is simply an
advertising opportunity, structure allows us to put price in perspective.

term, downside reference; let’s review the Profile from the early morning ‘pit’ session of September 29th to
determine the information delivered by the market structure as recorded via the Market Profile®.
8
1. The same trend line shown on the bar chart and the reference we identified in our blog.
2. An uncompleted auction; caution, this is just one data point. Notice the substantial difference
between this uncompleted auction and those in our last example, adding another time period to
the low would have delivered exponential information.
Exponential information, as it used here, simply refers to a rapid increase in importance, a two
wide low is not twice as likely to fail as a single print low but multiple times more likely, a three
print low is, again, many multiples more likely than a two wide low to fail.
3. The third auction period saw the market auction down and through the trend line; a simple price
based view witnessed the trend line being broken. A structural auction view saw quite different
information; the probe below the trend line was quickly rejected and the auction accelerated more
than $5 dollars higher over the next three days.
4. We likely would have never projected the magnitude of the auction; however, by identifying the
beginning of the auction you are now in a position to monitor for upside continuation with
excellent trade location. Structure—not price—contained the most important information.
9
RECAP: The study of structure and timeframes is a lifelong process; however, as a sign says as I enter my
health club reads, “A year from now you will be glad you started today”.
We provided two extremes to give you a base to illustrate the concept of structure. However, it should be
noted that structure is internalized over time, through various observations, as you watch the markets every
day
and
accumulate
experience.
Do
not
be
hard
on
yourself
as
you
assimilate
these
concepts
into
your
market understanding; it is one thing to be introduced to something but quite another to learn it and make it a part of
your thinking and your developing market perspective.
There is a common thread among the comments from our clients from both the very experienced to those just
starting to trade: you cannot hear or see this information enough. This was a driving factor in our decision to
create a video. Not only do I feel like the visual medium is the most powerful way to learn the markets, but it
also avails a trader the opportunity to review the material as many times as it takes to internalize the various
concepts that I employ in my trading.
Structure is

leveraging it in your trading, I believe, far outweigh the effort. Recognize and identify structure, think about
what it conveys in the broader perspective. As Benjamin Hoff states in The
Tao
of
Pooh, “much learning does
not create understanding”. Structure will help you understand the composite puzzle of the marketgenerated
information pieces and graphically conveys the broader dynamics of the twoway auction process.
Timeframes Tactics Guide
When trading begins to operate beyond the parameters examined in these examples you will begin to
sense longer timeframe involvement. Successful traders continually readjust their strategy and tacticsdepending upon timeframe involvement.
Timeframe Trading Behavior: Determining who is dominating in the market on any given day and
understanding how their participation will affect the auction process is crucial in determining one’s
trading strategy and tactical implementation.
For this article we have combined scalpers, day traders, and short-term traders into a single group
and classified intermediate and long-term traders into the second group.
The three most important aspects to trading are:
1. Understanding the markets natural two-way auction process and organizing that information so that you can interpret it to trade effectively
2. Understanding the auction’s different timeframe participants and each of their traits and
behaviors
3. Controlling and employing your emotions in a productive manner. [to trade successfully]
The dilemma of learning complex information: The whole is too complex to learn without
understanding each of the pieces, and each of the pieces can’t be fully learned and understood
without understanding their context within the whole. This is the same issue that scientists continually wrestle with. The global warming analysis is a prime example albeit on a much broader
timeline. Scientists must understand recent and current temperature excursions since they startedrecording this data; yet they must put these observations in context with long term climate changes
that have occurred prior to science even recording such information.
A note about conflicting information: What is not directly conveyed in the above point but is equally
important to traders is that there will always be an element of uncertainty when our analysis is completed. This is probably one reason why many traders continually dissect information,
attempting to ‘figure it all out’ before completing their analysis or, executing a trade. As humans we
have a propensity to seek certainty; however as traders, accepting uncertainty is a fundamental
necessity. To quote Karl Popper as he is cited in The Black Swan by Nassim Nicholas Taleb,”…
uncertainty is our discipline, and..understanding how to act under conditions of incomplete
information is the highest and most urgent human pursuit.” We highly suggest reading this book
listed on our Suggested Reading list.
The basic timeframe descriptions are recapped below. Chapter Three of Markets in Profile deals more in depth with the broader topic and the Field of Vision video takes timeframe analysis even
deeper as several differing live market examples illustrate this concept.
Timeframes: Market activity is influenced by a wide variety of participants operating under a wide
2
variety of timeframes and motivations. The way each of these participants combines and employs
information is different. For learning purposes we have segregated the markets into 5 timeframes:
1. Scalpers are very short-term oriented, trades being completed possibly in seconds; they rely primarily on intuition and order flow. Today most scalping is done via computer.
2. Day traders come to market each day flat (no position) and leave the day flat. Their behavioris very short-term and often emotional. They depend almost exclusively on market-generated information because fundamental information is too slow and cumbersome; fundamental
information can actually be counterintuitive for the day trading process.
3. Short-term traders’ timeframe is usually 3-5 days or slightly longer under the right contextual conditions. They supplement market-generated information with an awareness of
recent fundamental information and the effects this can cause on market movement. They
love to trade from the top to the bottom (or bottom to the top) of multiple-day trading ranges—5 to 10 days is ideal.
4. Intermediate-term traders’ timeframe covers weeks or months of market activity; they rely
on a blanched mix of fundamental and market-generated information. This timeframe prefers
to trade from the top to the bottom or vice versa of large trading ranges or balance. When theintermediate-term traders begin to dominate a market, their behavior is aggressive. While
they tend to dominate markets far less frequently than the short-term timeframe discussed
above, when they are dominant they are usually very aggressive and move the market substantially. Shorter-timeframe traders who are unaware of their entry into the market often
suffer substantial losses.
5. Long-term investors/traders may hold positions for months or even years; they are far more attached to the securities and investments they own. They tend to follow fundamental
information first, followed by market valuation, and finally market-generated information to
supplement their understanding of market activity. When they become dominant, markets can move out of the more traditional contained ranges of the other timeframes. They move
markets; and when they do, the other timeframes “pile on”.
LEARNING BY EXAMPLE
We have chosen Friday October 8, 2010 for our example. The monthly Jobs report, which is often
the most important economic report, was released and showed very poor labor conditions. This
would normally be expected to create volatility and interest among all of the timeframes. Let’s
review the S&P’s on October 8 th
in segments:
3
1. Opening—The opening immediately begins to prepare us for tactical trading; is the
market in or out of balance. On this day it is in balance; opportunities are likely small
unless the market immediately auctions out of balance.
Openings are important references for day and short-term traders.
2. The initial auction is up leaving a “local top”. Local top is a carryover term form the old
days when floor locals played a more important part in the market. Local tops provided
evidence that the floor traders were dominating the market; longer timeframes were absent. The locals could have their way with the market. Now we refer to this non excess
high or low (meaning no buying or selling tail) as a poor or unsecured high or low, which
communicates that day or short-term traders are in control. These traders are unlikely to
4
want to or to be able to move the markets very far out of containment areas; that is not
their style or interest. They prefer to trade within well established boundaries.
3. The two-way auction process at work—Once the initial auction ends it immediately
begins in the opposite direction; it continues until an opposite auction begins.
4. Half back—Half back is a simple linear observation that short-term traders use to judge
the day’s progression and serves as a day timeframe reference. It is simply the center of
the range. If the market, for example, has built up short-term buying interest, a pullback from the early high would likely find short-term buying interest at halfback; if there is
little buying interest, the halfback reference will not act as support and the selling is
likely to continue.
5. Prominent point of control (POC)-The width of the POC, or fairest price at which
business was being conducted, varies depending on the amount of volume that occurred
or time that was spent at this price level; the greater the time and volume spent at the
POC, the more prominent it becomes and the higher the odds that prices will revisit thislevel. We pointed out in our October 8 th
Pre-market update that the previous session
(October 7 th
) POC was very prominent and, as a result, presented high odds that prices would revisit it on October 8
th . (Some of you will have questions regarding many of the
terms; unfortunately, to explain them all here would cause us to lose the overall focus of
this trading education article. The books, video, blog, and these trading education articles are designed to become part of your accumulated experience.) The odds were correct; the
market opened higher but came back down to revisit this numerous times over the first
hour and a half of trading.
6. The downward auction terminates with a local low; the market remains within balance, i.e. within the previous day’s range. There is no indication of longer timeframe interest;
our combined group of scalpers, day traders, and short-term traders continue to have their
way with the market.
The two-way auction process continues to function as it begins to explore higher:
1. The two-way auction continues-Having stopped auctioning lower the two-way auction
continues in the opposite direction. The two-way auction process is the market’s way of searching for information and what is uncovered is referred to as market-generated
information (MGI). The Market Profile® is a time sensitive, evolving data base that
records this process.
2. Half back finds buyers rather than sellers; the next likely destination is the “local high”;
markets are very visual and, very often, trade to the next nearby visual reference. Any
trader can look at a bar chart quickly sees the morning high as a visual reference.
Current and previous day’s high
for intermediate- term rally
6
3. Developing value is unchanged from the previous day—If you will think in terms of
value versus price you will maintain a healthier perspective.
4. The “local high” is reached—The auction probes to the visual reference; our focus is
now on the continuing two-way auction process; does it reverse or continue.
5. Current longer-term and previous daily high—If the two-way auction continues
higher, the next references are the current longer-term rally high, which is also the high
of the previous day. (You mean here the balance area high of past 3 days=115860 area)
6. Destination-The next visual upside destination trade is to the top of these visual
references, this being the high of Thursday, Oct 7 th
at 116050.
7
1. The original “local high”—I’m going back to referring to my newer description as a
poor or unsecured high; that simply means that the odds of holding or remaining in place are low. The auction took out the high and continued upward.
2. The auction continues; during the auctioning process the auction’s goal is to discover a
level where two-sided trade can take place; this is the goal of any business-to involve as
many participants as possible. We monitor price acceptance or failure to determine if thiswill be the level.
3. Destination trade—Once again the visual, upside reference of Thursday’s high was
reached. I suggest that traders continually divide the market into segments delineated by as many visual references that are clearly defined and take the market one step at a time.
If we are in a long in this upward move, we monitor for continuation as each reference
comes into play.
A logical question—A logical question would be: how about the poor or unsecured low on October
8th, isn’t this important?
The answer is yes; in fact, it is important on the afternoon of October 8
th
. The poor lowwas an indication that the longer timeframes weren’t intently or aggressively involved in the market on this day, which greatly reduces the odds that the auction will carry very far
beyond the morning high. As the auction continued higher, trade expectations and profit
targets should have been relatively small. Looking for the ‘big trade’ on this day would have lead to disappointment.
This poor low is also important to carry forward after the Friday, Oct 8 th
session. This data point is part of market structure that you can read about in our Trading Education
article on 10-3-10.
Summary: Like an operating room, we have chosen a sterilized environment to examine our short-term trader combined group. I chose to say it this way: We have chosen to examine short-term
timeframe dominance by isolating this discussion to their behavior; how to recognize these
participants and subsequently the most effective trading tactics in any particular session. However it would be incomplete not to mention other factors to consider as your understanding develops and
you incorporate more context into your observations. Additional information to consider:
Volume: on this day developing volume was very low, which also reduced the odds of further
upside continuation.
Market confidence: tends to be low on those days that are controlled by scalpers, day traders,
and short-term traders with confidence being considerably higher on days that are dominated
by longer timeframes. When the longer timeframes are dominant the shorter timeframes tend
to pile on and drive the auction even further.
Observation: from observation you will see that quite often a daily high or low is established
during the first 90 minutes; once a directional auction begins to dominate it tends to go that way for the remainder of the day. On October 8
th , although the shorter-term traders
dominated, the market reverted to the longer-term trend, still relatively contained, and
continued through to the close.
Before we present the final three graphs I thought that the market would slightly extend the range in
the afternoon, which would be consistent with the capabilities of the combined scalpers, day trader,
and short-term traders; however, any measurable or lasting upward extension would be inconsistentwith this group; remember, they would prefer to trade within confined level only pushing beyond
those levels to trigger stops.
Destination had been reached and exceeded; stops triggered.
9
Once the highs were within reach the game became to go trigger the stops; stops are triggered by
bidding prices up until the stops are triggered. The profit occurs when the short-term traders that bid prices up to trigger the stops immediately sell into the additional rally created by the election of
those stops.
10
The final outcome-On this low confidence day dominated by scalpers, day, and short-term traders the market settled at the previous day’s high and had discovered the level where two-side trade could
occur. This is the market’s ultimate objective.
Our goal was to show you a low confidence day so that you would be better able to assess when a higher confidence atmosphere was developing; On a high confidence day the auction will generally
begin moving directionally much earlier and see much less rotation.
On a low confidence day your expectations should be greatly reduce, which allows you to adjust
your tactics and attitude toward risk.
DAY TIMEFRAME MARKET CONFIDENCE
Market confidence versus personal confidence—We very often get into trouble when our personal market confidence level differs from that of the market; these are also the days that our emotional decision making is more likely to become impaired.
Keep in mind that the direction that price is moving does not necessarily coincide withthe market’s level of confidence.
Patience—You often hear the advice that patience is required to become a successful trader; to that I answer a definite maybe. On those days that the market is exhibiting a high level of confidence you want to execute immediately. When market confidence is low, patience is required to let the market develop and identify an inventory imbalance.
Inventory imbalances—High confidence days may lead to inventory imbalances; however, they are seldom corrected within the same day. Low confidence days may offer several opportunities as short-term inventories constantly swing from too long to
too short.
Judging Confidence
Opportunit ies that involve longer timeframes versus the shorter timeframes: Is the market opening in or out of yesterday’s range:
Opening outside of yesterday’s range will certainly garner more attention and excitement than opening within yesterday’s range. This is far more likely to galvanize a directional opinion than opening within yesterday’s range.
a. If the market opens outside of yesterday’s range and doesn’t trade back into the range, conviction is likely to be high in the direction of the breakout. This is being written on the afternoon of October 14, 2010; the morning opening offers us the perfect example.
b. If the market is driven back within the previous day’s range the day timeframe confidence is more likely to be high that prices are too high.
Let’s contrast these two scenarios with two examples:
2
1. Market opens outside range, fails in its attempt to fil l gap, and moves higher:
1. Market opens out of balance to the upside. 2. Responsive sellers attempt to sell into higher prices. 3. Initiating buyers are strong, they are willing to buy above yesterday’s high;
gap is not filled. Day timeframe conviction is high if buyers are willing to pay 10, for example, for something they could have bought for 7 yesterday. The
issue is not if they will be proven right or wrong over time, or that you agree or disagree with their decision, but rather that their conviction is high today.
4. For several periods the market one timeframes higher; one-timeframing is another sign of, at least, short timeframe confidence.
S&P 500 December 2010
Morning of October 14, 2010
3
2. Market opens outside of balance and finds price accepted back within the previous day’s range:
1. Market opens outside of balance. 2. Responsive sellers take advantage of advertised opportunity to sell price
above value; initiating buyers are absent on this occasion. 3. Near the previous day’s low, responsive buyers step in. It is importance to be
able to contrast the level of confidence in this example versus our prior
example. In our prior example initiating buyers were one-timeframing higher; in this example the responsive buyers were only able to rally the market for the second and third periods.
4. Sellers reentered on the rally and drove prices out of balance to the downside. What I want you to feel, at this point, is the difference in confidence between the first and second examples. The lower confidence in the second example led to an afternoon rally, unchanged value for the day, and higher price. Had you been able to reflect on the lower confidence in our second
S&P 500 December 2010 Morning of October 7, 2010
4
example your own emotions might have been tempered, which would have reduced your downside expectations, allowing you to have exited a short and possibly opened your mind to a long trade.
Opportunit ies that revolve more around day timeframe traders:
Markets that open within balance (within the previous day’s range) are far less likely to initially involve the longer timeframes. At the lowest extreme the market would be dominated by the day timeframe traders; it is rare that this timeframe can dominate for the entire day making it important for us to learn to recognize when subtle or maybe not so subtle shifts in control begin to appear.
Note: For educational purpose we have made this b lack and white; however, that is rarely the case. Once you grasp the references and concepts they will be transportable.
a. The Opening: Day timeframe traders focus on the opening to determinedirection or lack of direction. See Mind over Markets as an introduction and the Field of Vision video for more in depth discussion of openings. Back and forth through the opening multiple times signifies low confidence; it is not the time to initiate a trade. A direct march away from the opening signifies a higher level of short-term confidence. If a market has advanced, for example, and then pulls back to the opening without going back through it the chances are good that the market will perform another short-term rally. If price is allowed back through the opening confidence is weak.
b. The previous day’s extremes: Markets in Profile discusses the behavior of the various timeframes as does the Field of Vision video; the expected behavior of the day timeframe is to trade within a predefined range exceeding the previous day’s extreme mainly to trigger stops. If there is price acceptance beyond the previous day’s range it is usually an indication of the entry of, at least, the next longer timeframe—change is occurring.
c. Unchanged: Day and short-term traders focus intently on unchanged price from the previous day; if the market is falling, for example, and price can’t get below unchanged the odds of a rally are high.
d. Halfway back: I lost my best trading friend last year, he was a short-term hedge fund trader known as the king of “half back”; the first 30 minute period has a center of that range, which is referred to as “half back” or half way back. If he wanted to buy and the market rallied prior to him getting his position on he was an automatic buyer at half way back. As the range for the day extends there will always be a center of the daily range; that center or half back continues to be a short-term reference throughout the trading day.
e. Overnight high and low: These are, like the previous day’s high and lows, very visual and visual day and short-term references.
As this is being written the following example serves to help our appreciation of a previous day’s low as a day timeframe reference.
1. The market’s opening; our initial reference.
2. The first auction was up 3. The next auction came back through the opening—a sign that we were
not at the highest confidence level. At the highest confidence level the opening would have been the low of the day.
4. The auction stopped at one tick above the previous session low; mechanical trading off this reference indicates that day timeframe traders are dominating the market. Longer timeframes could care less about a single tick; again, review Markets in Profile, and for more in depth analysis the Field of Vision video, for a clearer understanding of this discussion. It is important to understand the thought process of the different timeframes.
5. The day timeframe traders immediately rallied the market once the low held; you will not have much time to make up your mind at these lows.
6. The rally off the lows began to stall at the original opening price.
Without understanding the process described above you are much more likely to get entrapped by price, emotionally selling into the early break. This process only works if you truly understand it and remain fluid; if the prior session low isn’t taken out very
S&P 500 December 2010 Morning of October 14,
2010
6
quickly you must exit immediately; the counter auction can be very sudden as day timeframe shorts cover and day timeframe traders buy; this is their game, not yours.
Early morning highs and lows: Early morning highs and lows are also natural references when the day timeframe is dominating the market.
Observations We have tried to give you an idea of what to look for; it will only be yours after a period of observation and trade execution. Trading experience is accumulated slowly and over time. Without knowing what to look for it is difficult to begin the path toward expert trading. We hope these concepts provide you with fundamental observations that will help you move toward this goal.
KNOWING WHAT TO LOOK FOR
The first riddle I ever remember hearing was asked by my mother; “When you are
looking for something why is it always in the last place you look?” Of course I waspuzzled until she said, “because then you stop looking because you found it.”
Sometimes in trading we look right at something we were looking for but don’t realize
we actually found it, and so we continue looking. We are constantly writing that markets
are very visual, which means that, very often, they will auction to a level that is very
visual on our charts and graphs. Along with this we often attempt to identify potential
“destination” trades; the destination is also a very visual market level. We are not saying
that the market will necessarily arrive at the destination; however, if the market begins
to auction in the direction of the destination it is certainly a targeted level. Let’s look at
an example from Friday Oct 15, 2010 that meets both of the above qualifications: it isvisual and a likely destination.
Opens in lower range
of two day balance
and auctions out of
2
We always talk about levels rather than specific prices; attempting to try and be too
exact will, very often, freeze you in place as you try to squeeze out every penny from
the existing trade or cause you to miss initiating a new trade. Let’s examine the same
trade via the Market Profile.
Practical application:
1. Consistent and return readers know that one of our favorite trades is a
breakout from balance; breakouts represent change and change spells
opportunity. Consider if you came into the morning with a plan recognizing the
two day balance in context with the longer term conditions. We refer to a
trading plan as a Narrative, which is your overall view of the market. Following
the narrative are a series of scenarios. Scenarios are possible directional
trading events for the day; one of the scenarios in the above situation would
be for a downside breakout. See our balance rules in our glossary for further explanation of how we trade balance areas.
2. Value immediately begins to build lower; we trade value not price.
3. During G period, the seventh 30 minute trading period, the auction begins to
auction aggressively lower. A visual market audience, these are likely to be
skilled and experienced traders, has already locked in on the visual gap as a
likely target. Who do think has the edge?
Market opens and is trading out of balance
CRUDE OIL
3
Visual perspective: Anyone with experience knows that the previous day’s high and
low are relevant to today’s trading. This high or low may only be relevant in slow
markets because shorter-term traders want to run the stops and fade price moves back
into the range. However let’s extend this to longer time periods. On those days that the
longer timeframes have an interest, whether it is to “go with” a breakout or fade the high
or low, a longer-term high or low is very visible as well.
For example, if a trader did not look at the monthly or the weekly bar for the 30 Yr
Treasury bond below, he probably would not have recognized the price level(s) that
may interest the longer timeframes; it is unlikely he will have a longer-term perspective.
The Field of Vision video discusses this in depth; understanding timeframes and how to
interpret their participation takes experience gained over months and years. We suggest
labeling references in terms of timeframes (day, short, intermediate, long-term) so that
you have a better appreciation of references.
This monthly Treasury bond chart was captured on Saturday, Oct 16, 2010. As I edit this article on Monday, Oct 18, 2010, bonds closed at 132.06, more than a handle off
the two month balance low of 130.25; do you think this rotation back up into range is the
result of the day timeframe trader? Probably not.
Oct low
4
The monthly bar allows for a visual review of the previous month’s highs or lows exactly
as a daily bar or weekly bar would do for shorter timeframes. In the above example you
see that the October low failed to take out the September low by three ticks. The
majority of struggling traders I talk with have no idea about these important visible
references. If you have not looked at the charts and you are not aware of the
references, you will be at a disadvantage for day trading or longer-term trading when
the level is reached.
We refer to this as a “Top down-Bottom up” approach: first gain a bigger market
perspective by looking at the longer-term charts. Then use short-term and day
timeframe market-generated information to formulate strategy and a tactical plan from
the ‘bottom up’.
Visual perspective continued:
5
We often get so focused on the short-term, economic reports, and the talking heads that
we fail to keep a perspective of what the market is actually doing; a visual look at the
monthly bar quickly allows you to see that;
1. We see an excess low near the 1000 level back in July—excess is one of the
most important concepts we work with. 2. One-timeframed higher for three months in a row.
One of the best ways to ward off cognitive dissonance is by maintaining a solid overall
perspective of the market.
We could certainly add multiple examples; however, the objective was simply to expand
your awareness of how visual the markets are. When you reflect back on this idea you
quickly realize how logical it is. We are drawn to what we can see and become
comfortable using it to our advantage.
Depth and market perspective will increase when you start to view longer-term charts in
conjunction with the short-term. Many traders do not review the longer term charts or
they just have a cursory look. Or, they are looking at indicators or other derivatives of
price rather than observing the visual levels on the charts. Often times the relevant
information is right before our eyes; but if we don’t know what to look for, it’s difficult to
find it.
Going beyond the Majori ty of Those You Compete Against
What we have shown so far is available to all that have access to traditional bar charts;
we can take visibility up another level by viewing Market Profiles ®
. The Market Profile ®
is actually a real-time, time sensitive, evolving data base that displays its data in structural
form via the Profile graphic. The bar charts that we reviewed earlier are one
dimensional; a Market Profile® is two dimensional which allows us to see the market in
greater depth. We can see patterns via the structure that allows us to differentiate
between price and value, which is at the heart of all rational decision making. We can
also observe patterns that suggest that inventory in different timeframes is either too
long or too short. Additionally, we can see anomalies in the structure that need to be
repaired. Repair can only take place when price returns to the scene of the anomaly.
Let’s view a couple of examples.
6
An anomaly is a single price or level that lacks symmetry, an unusual structural
arrangement in the Market Profile®; the above is described as an anomaly because
price traded at the POC or fairest price to conduct business in all but one of the daily
time periods, a very rare occurrence. The odds are very high that this anomaly will be
revisited; it normally requires substantial volume away from the anomaly to open and
not revisit such an anomaly. Those who had visual access to the Market Profile had a
clear advantage. Note: I understand that the above paragraph lacks a full description
and explanation; however, the point of this article is to highlight the importance of visual
market references.
Our final example is more complex and subtle; however, we have several clients that
have effectively traded with this visual picture in mind.
S&P 500 DEC 2010
7
1. Our starting point; a fairly balanced day; notice the anomaly at 82.08 and how
visual it is.
2. Market opens and rallies to 83.07 in 2nd period (B) before retracing to trade at
anomaly from day one. We are overusing the word anomaly here; we would
normally refer to the anomaly level 82.08 as the POC or fairest price at which
business is being conducted.
3. Shifting gears; I want you to notice how almost perfectly the daily lows are
beginning to fit a short-term trend line—this is a very visually displayed.
4. The market continues to conform to the visual trend line.
5. The mechanical trend line that has been the buying reference for the short-
term momentum traders.
6. Once the mechanical trend line that has been buy point for the momentum
traders is penetrated, one set of stops sets off another, sets off another, etc.
8
Explanation: Our goal continues to be to focus on how you can use your eyes to
become a more proficient trader; however, a brief discussion will be helpful. When a
market conforms almost perfectly to a rising trend line it is often a sign of mechanical,
short-term momentum traders continually getting longer and longer. Longer-term buyers
are unlikely to attempt to be as exacting as their size makes this impractical. As these
short-term traders continue to take long positions, they are likely placing protective
stops below each new daily low.
Point 1: As long as you understand exactly what is occurring, you can benefit in two
ways:
1. Employ short-term day trades going with the short-term trend; buying as close to
the trend line as you can. I’m not a trend line person; however, if this is what the
momentum traders are doing, go along, it is all a game anyway. The key is to
fully understand the game and be ready to exit immediately if price begins to find
acceptance below the trend line.
Recall that we assumed that these traders are placing stops under each new daily low;
as the rally continues long inventory continues to build with weaker and weaker hands,
which we refer to as laggards, holding the inventory. It is important to recognize the
game and to feel the greed of the laggards, knowing that inventory is likely getting into
weaker and weaker hands. This process can continue for extended periods if nothing
knocks the traders off track; traders will continue to do what works until it stops.
2. Once a correction gets underway and the stops begin to get triggered, it is very
often, like a pack of firecrackers being ignited. When the first stop level istriggered prices are driven low enough to trigger the next set of stops, etc. You
will often see several days of gains erased in a single session. If your imagination
felt the inventory accumulating within the hands of weaker and weaker traders
you would be able to visualize the liquidation if it occurs.
Imagination + Analysis = Comprehension is our tag line for our video and website;
being able to visually see the market can greatly increase this process of imagining the
possibilities and being prepared. Review the last example and begin to appreciate how
an understanding of what was occurring will help you imagine the break on the last day.
Trading is about employing all your senses to compete successfully; too many traders
remain too narrowly focused on price and short-term bars, never fully appreciating the
market’s natural two-way auction process, the multiple timeframes, and the expected
behavior of each of these timeframes. Taking the broader view will not only expand your
market perspective but it will also protect you in the day timeframe from being
mesmerized by price.
BUYING AND SELLING TAILS AND TRADER DEVELOPMENT
I write this article not only to discuss buying and selling tails and their absence, but also to take this opportunity to illustrate the learning process and our development as traders; how we come to increase our market understanding and the obstacles that often confront us in
the process. As I mentor other traders I am reminded of my own learning process incoming to trade market-generated information.
I have often commented that learning about buying and selling tails was one of the most costly concepts introduced to me. Tails are only one data point; however, when we first become aware of them they are so linear, visual, measurable, and intuitive, that we lean on them, seeing them as an actionable trading tactic. When our observations result in profitable trades, we become even more sensitive to their forming. We start to look for them, often at the expense of more important market-generated information that is developing. Said another way, our focus often narrows to hone in on tails, much like when you buy a car and start to see your car model on the road everywhere. The car was always in your sight; what shifted was your focus.
Clearly this is not exclusive to buying and selling tails; it happens with all market-generated information that we begin to build into our market understanding. But buying and selling tails are rather dramatic and linear and therefore accentuate this process. Tails can be powerful; they represent excess, one of the most important concepts we deal with. Seeing excess in the day timeframe with a buying or selling tail often offers an asymmetric opportunity. However, many equally excellent day trade opportunities present themselves without the emergence of tails—in the form of poor highs and lows; this market-generated information warrants discussion since not capitalizing on these opportunities limits our versatility.
I realize that in this article many readers may have as many questions as answers. Some of this analysis is ambiguous and difficult to quantify. To quote Nassim Nicholas Taleb from The Black Swan, “We tend to learn the precise, not the general.” However focusing on the precise—price—in this instance (and in many other market situations) to guide our trading decisions will often lead us astray. We all gravitate toward the linear—our brains love patterns and linear data which it can catalog and act upon. It’s comforting to lean on this type of information. However in my forty years of trading I have found that there is little opportunity in trading linear relationships over the long-term. Where we find comfort is not necessarily where we will find trading profits.
The fact that this discussion is not linear does not detract from its effectiveness and our ability to trade it. It does however require a more conceptual understanding rather than an awareness of technical information.
Some of the Condit ions that Lead to Poor Highs and Lows
Poor highs and lows are often precipitated by an extended rally or break. We often say, “Traders will continue to do what works until it doesn’t work anymore”. In the example of the Treasury bonds we are going to use, the sentiment was, ‘buy the breaks and keep buying’ in response to the Fed announcement in early August that it would support the market. The market inventory continued to get longer as time went by; inventory was
2
becoming excessively long. Remember as we continue this discussion, that inventory imbalances happen in all timeframes. See the daily Treasury Bonds chart from mid August to mid October 2010 below:
The Treasury bond daily chart shows that the poor highs that we will see in the next Market Profile® chart formed in a market which had been trending up. Notice the advantage of employing the broader perspective: the poor highs were occurring at a longer-term reference as well.
Other considerations in viewing the longer-term: Are these poor highs or lows being made with or against the trend? Also, is the trend young or tiring?
As with all market-generated information, successful analysis views the puzzle pieces in
context with the larger whole. Inventory: Employing the Market Profi le® to Observe the Shorter-Timeframe
Inventory is a primary consideration in understanding poor highs and lows and will show itself first in the daily Profiles. There is market-generated information in the lack of a buying or selling tail. It may be conveying that inventory is too long or too short. To keep this real let’s consider the auction process and the human participants who drive it.
When a market is too long there are often many weak holders that are selling every rally. This selling pressure caps the upside momentum and stalls the probe higher. The longer
3
this continues, the more uneasy these weak hands become. Inevitably, as anxious traders enter sell orders to exit, a liquidation break ensues. This scenario highlights a common market occurrence: before the market continues higher or lower, it has a way of shaking out the weak hands. The final outcome is that as the weak hands are cleared out on the break, the long inventory changes to stronger hands; the market is now positioned to rally.
This market dynamic is the driving point behind the comment that “sometimes a market has to break before it can rally” or “rally before it can break”; excessively long (or short) inventory often has to be balanced. Like any business, the market must take care of current business first. The inventory imbalance and its effect on the two-way auction process needs to be addressed before the auction can probe higher. To fine tune our analysis of the Treasury bond daily bar chart we viewed earlier, let’s look at the Market Profile® chart from Oct 6th to Oct 13th:
Analysis also must consider multiple, consecutive poor highs or lows—this accumulating
market-generated information has an exponential effect. The four poor highs and theoutcome in the 30 Year Treasury bond provide a good example of this.
Clearly the break on October 13th was liquidation; it does not appear to be new money, longer-term sellers entering the auction; however we also recognize that liquidation breaks can lead to new money selling. There are no hard and fast rules but the odds are that these poor highs will be revisited prior to substantial new money selling. The poor highs above leave behind what we would consider poor structure. The odds are that poor structure will be repaired. We carry forward this multiple poor high information in our market perspective for the upcoming trading sessions.
Recognizing Timeframe Inventory Imbalances
As we said earlier, inventory imbalances occur in all time frames. As an example, it is not unusual to see day timeframe participants go from being too long to too short at various points throughout the session. The day timeframe adjusts its inventory in a matter of hours
in most cases, before the end of business for the day as we will see in the S&P October 8
th
example that follows.
Our Market Profile® Treasury bond example above conveys the poor highs that developed between Oct 6th and Oct 11th. As of this writing on October 15, 2010, bonds have fallen over $4,000 per contract. Clearly this inventory adjustment involves the longer-time frame. Shorter-term traders will do well to appreciate inventory conditions and remember that the actions of the longer timeframe always trump those of the shorter timeframes. As a short- term trader, fading these types of moves can be financially painful.
Poor Highs and Lows in the Day Timeframe: E-mini S&Ps on October 8, 2010
We can see the initial balance low at 115150; there was no range extension in the 3 rd auction, C period. A trader could be hesitant to take a long position based on the price failure—it was a poor low—yet it was the best trade of the day. Poor lows may represent lack of aggressive buying interest but they can also represent inventory that has gotten too
short, or simply reveal an environment being dominated by the day timeframe. Day timeframe traders often step in to buy the lows or sell the highs creating poor highs and lows.
Clearly it is important for traders to determine the difference, whether there is a lack of aggressive buying that suggests more downside follow-through, or inventory that has become too short, helping a trader visualize the potential for a rally. What market- generated information can we employ to help us make sense of this conflicting information?
5
1. How a low or high is made: This is incredibly important, particularly in the day timeframe. This is but one in a string of examples of why trading requires total absorption. When prices came down to this low the tempo slowed; they tried to press lower for the first hour but as time passed, in C period the shorts could not take out the early session low— not even by a tick. The longer we stayed at or near the lows without downside follow-
through, the more anxious the day timeframe shorts became.
No tail emerged yet this was an excellent long. Important to note, a trader does not feel tempo and confidence without being totally absorbed; we gauge our sense of tempo not only in the session but also over time, gaining a feel for how the market we trade moves from day to day. Tempo gives an edge to those who are focused and understand how to employ it in their tactics. Tempo is a feeling, a sense, if you will, that once developed will distance you from your competition.
2. Think about your competitors: What they are doing, how they are feeling, and what they are likely to do as a result will add a dimension to your market observations that transcends the linear data. Those that shorted the push down in the morning were not getting much for it…the longer prices stalled the more anxious, or at least uncertain, they were becoming. As prices started to tick higher, traders began to cover; the buy orders entering the market pushed the market higher which in turn fueled more shorts to cover and attracted the day timeframe momentum traders. The short covering rally was in full swing, confirmed when the fourth auction opened above the open, never to return.
3. What timeframe is dominating: This is tied to the above comment as we understand our competitors in this light. See the E-mini S&P chart below from Oct 5 through October 8, 2010:
6
If in recent days we are seeing light volume and short-term traders dominating, we use this information and our understanding of their behavior as the session unfolds on Friday Oct 8th. We opened in balance (meaning we opened inside the prior session range), a balance that had been relatively contained for the past three trading sessions.
We know that if we don’t move outside the containment range relatively quickly our short-term competitors are likely still dominating. As the market pushed down and could not come close to taking out the prior session low while the tempo was stalling, we consider this within our understanding of short-term trader behavior. They have little interest in moving prices outside of containment. We can expect going forward that we may see our short timeframe participants enter the auction to take advantage of this price probe failure to take out the early morning low. A poor low would be a natural development given this scenario. This had been the game for the past several days. Traders had very little reason not to continue this strategy when little had changed on the morning of Friday, October 8th.
As exemplified above, short-term traders dominating a market often lead to poor highs and lows since their behavior is to buy early morning highs or lows and other visual and exact references. Again, get inside the heads of your competitors; understand who you are competing with, their behavior, and what they are likely to do. Markets in Profile provides a solid framework for building your foundation of this important concept and this is described in more depth in several market examples throughout the Field of Vision video.
4. Put things in perspective: In the broader context, Friday’s low could not even come close to the low from Thursday. Understanding who was in the market and the failure to reach the prior session low strengthened your ability to visualize what might be coming around the bend. The longer-term upside trend was still in place, the buy was with the trend.
5. It is important it is to be thinking forward rather than be overly focused on what has already transpired. As prices couldn’t break lower I started to think about the inventory, who my competitors were, how they were feeling and what would likely happen if prices started to probe higher.
Poor Highs and Lows—Carry Them Forward
Coming back to the very subtle yet important point made earlier about being totally absorbed: the lack of a tail can benefit you tactically when you are immersed in the trading day. As prices came down to the initial balance low, I was cognizant of the poor high made earlier (see chart below). I know that if I don’t see follow through after the market auctioned away from this poor high, the odds of taking this poor high out have increased considerably. The auction Friday morning presented this scenario. Sometimes it takes several hours for a poor high (or low) to be revisited; however on this day it happened rather quickly. Recognizing the poor high provided more confirmation that when C period stalled at the lows, we were likely going to rotate back up. The split out E-mini S&P chart for Oct 8th shows the poor high formed early, prior to prices coming back down to test the early session low:
7
Summary
There are many elements to consider as we view the auction process. We often discuss the learning process and accumulated experience; that it takes time to internalize the various elements and how their interplay affects a trader's market perspective. The good news is, once you begin to understand and trade these concepts, your depth increases
and you build on this base. This approach is not about an indicator, a price level ormechanical references. Reflecting back to my comments at the beginning of this article, in my forty years of trading I have found that there is little opportunity in trading linear relationships over the long-term. Market environments change; exogenous events, political situations, and changing market inter-relationships affect the markets differently over the course of time. Long-term, successful traders recognize this reality and develop their market understanding accordingly.
Perspective: The Open
As the market opens we begin to receive day timeframe marketgenerated information that we
build into
session’s
range? Do we see directional conviction at the open or are prices rotating back and forth? Is
price moving away from value, and if so we ask, will price be pulled back to value or will value
likely follow price? We begin to gauge the tempo and record the initial balance as it is
developing—in its range and its relation to recent value. We are cognizant of our references
and we observe price behavior around these, gauging for acceptance or failure.
These observations come together to help us determine what timeframe appears to be
dominating in the market. We can then choose, to the best of our ability, the most effective
strategy and tactics to capitalize on the twoway auction process. For example, if we sense
shortterm participants dominating, we can lean on mechanical references such as overnight
high and

references. If we see directional conviction we consider that perhaps longerterm participants
are dominating and we look to longer timeframe references and start to visualize the
possibilities given the bigger picture market perspective.
The Market Profile ®
updates in real time to convey these pieces of marketgenerated
information and helps us to observe, in context, what is

J. Dalton - Trading Articles

Documents

Transcript of J. Dalton - Trading Articles