Candlesticks With Market Profile

"Existing together, thriving together"

Market Profile®, used by many futures traders, presents information about the markets that was previously only available to those in the trading pits. Market [email protected] technicians understand the internal structure of the markets. It offers a logical, statistically based analysis of price, time, and volume. This section examines only a few of the many tools used by followers of the Market [email protected] Topics such as different types of profile days (that is, normal, trend, neutral, long-term market activity charts, and so on), or the Liquidity Data [email protected] not be discussed here. The goal of this brief introduction is to alert the reader to a few of the unique insights of the Market [email protected] how it can be used in conjunctionwith candlesticks.

A few of the elements underlying the Market Profile® are:

1. The purpose of all markets is to facilitate trade.

2. The markets are self regulating. The regulating constraints include price, time, and volume.

3. The markets, as they attempt to facilitate trade, will use price probes to "advertise" for sellers or buyers. The reaction to these probes provides valuable clues about the strength or weakness of the market.

The Market Profile® organizes daily action into half-hour periods and assigns a letter to each half-hour period. Thus the " A period is from

Initial Balance

Initial Balance

Selling Extreme

Selling Range Extension

Selling Range Extension

Selling Extreme

Close

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Source: Market Profile is a registered trademark of the Chicago Board of Trade Copyright Board of Trade of the City of Chicago 1984. ALL RIGHTS RESERVED

Buying Extreme

EXHIBIT 17.1. Example of the Market Profile®

Source: Market Profile is a registered trademark of the Chicago Board of Trade Copyright Board of Trade of the City of Chicago 1984. ALL RIGHTS RESERVED

8:00 to 8:30 a.m. (Chicago time), "B" is from 8:30 to 9:00 a.m., and so forth. For markets that open before 8:00 a.m. (such as bonds, currencies, and metals), the first half hours are usually designated "y" and "z." Each letter is called a TPO (Time-Price Opportunity). The half-hour segment represents the price range that developed over that time period. This is displayed in Exhibit 17.1.

The first hour of trading is labeled as the initial balance. This is the time period when the market is exploring the range of trading. In other words, it is the market's early attempt to find value. A range extension is any new high or low made after the first hour's initial balance. Exhibit 17.1 establishes a selling range extension, but since there are no new highs after the initial balance, there is no buying range extension.

Value, to those who follow Market Profile6, is defined as the market's acceptance of price over time and is reflected in the amount of volume traded at that price. Thus, time and volume are the key ingredients in determining value. If the market trades briefly at a price, the market is indicating rejection of that price. That is, the market has not found "value." If prices are accepted for a relatively extended time with good volume, it connotes market acceptance. In such a scenario, the market found value. The market's acceptance of price is where 70% of the day's volume occurred (for those familiar with statistics, it is one standard deviation which has been rounded up to 70%). This is defined as the day's value area. Thus, if 70% of the volume for trading wheat took place in a $3.30 to $3.33 range, that range would be its value area.

A price probe is the market's search for the boundaries of value. How the trading and investing community acts on such price probes can send out important information about the market to Market Profile® users. One of two actions occur after a price probe. Prices can backtrack to the value area or value can relocate to the new price. Acceptance of a new price as value would be confirmed by increased volume and the time spent at that level.

If prices backtrack to value, the market shows a rejection of those prices that are considered unfairly high or low. Quick rejection of a price can result in what is called an extreme. An extreme is defined as two or more single TPOs at the top or bottom of the profile (except for the last half hour). Normally, an extreme at the top of the profile is caused by competition among sellers who were attracted by higher prices and a lack of buyers. A bottom extreme is caused by an influx of buyers attracted by lower prices and a dearth of sellers. Buying and selling extremes are noted in Exhibit 17.1.

How the market trades compare to the prior value area also discloses valuable information. Market Profile followers monitor whether there is initiating buying or selling, or responsive buying or selling. This is identified by determining where the current day's extreme and range extensions are occurring with respect to the prior day's value area. Specifically, buying below the prior day's value area is deemed responsive buying because prices are below value and buyers are responding to what they perceive to be undervalued prices. These buyers expect that prices will return to value.

Sellers at prices below the prior day's value area are said to be initiating sellers. This means they are aggressive sellers since they are willing to sell at prices under value. The implication of this is that they believe value will move down. Buying above the prior session's value area is initiating buying. These aggressive buyers are convinced that value will move up to price. Otherwise why buy above what is now perceived is as value? Sellers at prices above the prior day's value area are responsive sellers. They are responsive to higher prices and expect prices to return to value.

Trading should go in the direction of the initiating group unless price is quickly rejected. Thus, if there is initiating selling activity (extremes range extension), under the previous day's value area on expanding volume, it should have bearish implications.

Market Profile® with Candlesticks

Exhibit 17.2 reveals how a doji on July 2 and a hanging man during the next session were candlestick alerts of a top. What did the Market Pro-

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Source: Market Profile is a registered trademark of the Chicago Board of Trade Copyright Board of Trade of the City of Chicago 1984. ALL RIGHTS RESERVED

[email protected] during this time period? July 2 had a relatively small value area as compared to the prior session. It was also a light volume session (132,000 contracts as compared to 303,000 the prior session). This hinted that price was having trouble being accepted at these higher rates. In other words, there was lack cf trade facilitation. It is also a profile with range extension to both sides. This indicates a tug of war between the bulls and bears.

July 3 was another light-volume session (109,000 contracts) which significantly discounts the bullish developments-an upside range extension and a close at the highs of the day. The next day, July 5, is where the weakness of the market materializes. During the early part of the session, new highs were made for the move. In the process, upside range extensions were also formed. With these range extensions, the market was advertising for sellers. They got them. The market sold off toward the latter part of the session (the J, K, and L periods) to close near the low of the day. The open of July 6 saw initiating selling on the opening since the market opened under the prior day's value area. This showed immediate selling activity. July 6 also displayed increased volume and an initiating selling extreme (that is, single prints at the top of the profile) during the "y" period. This confirmed the market was in trouble.

In this example, we see an important aspect about the hanging man previously addressed; it is only what happens after that line that makes it a bearish indicator. July 3 was the hanging-man day. Here we see the Market [email protected] of the hanging-man line was giving some positive indications about the market. It was only on the following session, July 5 and especially the morning of July 6, that a top was also verified via Market ProfileB.

Exhibit 17.3 shows that July 5 was a very evident shooting star. After this line appeared, cotton plunged for three sessions. Was there anything prior to the shooting star a la Market Profile @which gave signs cf trouble? Yes, there was. From June 29 to July 3 prices advanced but by way of a shrinking value area. This meant less trade facilitation at higher prices. The market was having trouble accepting these new highs as value. In addition, volume, as gauged by the total number of those session's TPO counts, was decreasing (actual volume was light on these sessions. However, since volume is not released until the following day, the TPO count can be used as a gauge of volume). Notice of a top was provided by the shooting star of July 5. The Market [email protected] that session showed a range toward the upside failed to get buying follow-through. Additionally, the entry of sellers attracted by these higher prices drove the market down as indicated by the range extension down and the weak close. These were bearish signs.

264 The Rule of Multiple Technical Techniques

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Source: Market Profile Is a registered trademark of the Chicago Board of Trade Copyright Board of Trade of the City of Chicago 1984. ALL RIGHTS RESERVED

EXHIBIT 17.3. Cotton-December, 1990, Daily (Market ProfileB with Candlesticks)

IF more proof was needed, all one had to do was wait until the opening of July 6. An initiating selling extreme developed on the opening under the previous day's value area. This confirmed the presence of sellers and difficulty ahead. Thus, the Market [email protected] confirmed the bearish implications of the shooting star.

There are some interesting similarities between Market Profile® concepts and candlesticks. Wider value areas in Market [email protected] represent facilitation of trade and, as such, increase the probability for price trend continuation. Thus, in an uptrend, one would like to see widening value areas. Likewise, with the candlesticks, one would like to see a rally via a series of longer and longer white real bodies in order to confirm the power behind the move.

Shrinking value areas in Market [email protected] less facilitation of trade and thus less certainty of a continuation of the price move. So it is with the candlestick's advance block or stalled patterns. In those formations, the trend is still up but it takes place by means of shrinking white real bodies. These formations indicate that the prior momentum is running out of steam.

What about a star in candlesticks? A short real body in an uptrend or downtrend would be a sign of decreasing vigor by the bulls (a star in an uptrend) or the bears (a star in a downtrend). So would a small value area after a strong advance (or decline). The small value area would reflect a lack of trade facilitation. They could be a harbinger of a trend change. A hammer's lower shadow might be formed due to a buying extreme in which lower prices induce an influx of buyers. A shooting star's long upper shadow could be the result of a selling extreme in which higher prices attracted strong selling.

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