Auction Market Value Theory & Analytics

Information Derived from the Observables
Market observables deal primarily with prices and trading (volume). Auction Market Theory owes it's utility to value. In this section, the first steps are taken to convert the one-dimensional price to the two-dimensional value description of auction markets. First, the observables are fleshed out.

1) Trading hours.
Non-electronic markets open and close at set times. Trading is tied to the market timeframe. Orders accumulate between the close and the next day open, creating an order backlog. At the close, traders who do not wish to hold overnight must exit their positions. In this simple way, market hours exert a level of control over trading structure. One of the ramifications of trading hours is a specialized behavior pattern in the first hour of trading. This timeframe is called the initial balance because floor members seek to define the trading range for the day from the order backlog. How well they accomplish a stable balance affects the subsequent trading for the day. At the market close, those who must trade tend to create an extended closing range. At the very least, the closing range is deleterious to the public trader since their 'market on close' orders most often get the worst side of the range.

Electronic markets tend to show much the same structure as the floor because arbitrage exists and they often take their cues from the floor. As electronic trading matures*, those markets will likely lose a large part of their dependence on the exchange floor. (*that was written 12 yrs. ago)

Exchanges, or clearing authorities for some electronic exchanges, interact with the public principally in setting margins. Margin is 'earnest money' guaranteeing the broker that losses are covered. A trader's interest in margins in part is the amount of money that must be deposited in order to trade. Far more important is how the exchanges set margins. With a lot of experience backing them up, the exchange margin is set to mirror the risk. Trading models inevitably have a risk function of some sort. However, anytime exchange margin is changed, there is a change in the risk being taken. Since exchange margins are not necessarily what a broker charges, (brokers often charge more), keeping track of exchange margins takes some effort.

2) Prices are Set by Negotiation
Each trade has a buyer and a seller

3) Accepted Prices
An accumulating market has a single price - volume distribution roughly in the shape of a bell curve.

4) Rejected Prices
Prices not accepted by the market generate very light volume. Such prices rarely trade and the trader who wants to do business there has little opportunity to do so.

5) Accumulation and Distribution
The accumulating gives way to a distributing, or moving market

6) Day Traders and Swing/Position Traders
Day traders, by definition, are out of the market by the close. They have no long term effect on the market, since they are holding positions only a fractional part of the day and not at all overnight. Markets do move, and sometimes rather violently. Exchange members, as a group, tend to be flat or hedged at the close. Longer term demand, the sort that moves markets, comes from those who hold positions past the close. These are the position traders in the futures, options and debt markets; and the institutions and public in equities. Day traders are the opportunists who jump on a move and hold a short time. Position traders have the patience to hold longer term, creating demand.

7) Day-by-Day Variation in Market Activity
Perception of opportunity drives the day and short term position trader.

8) Heavier Trading at Open and Close
It was pointed out in item 1) that markets with floor trading develop a backlog prior to open. The necessity of day oriented trading exiting prior to close develops a backlog there, also. Since both open and close have associated ranges, demand is artificially changed at these particular times. With the rise of electronic markets, artificial demand from exchange openings and closings will disappear.

9) Trading Ranges
Short timeframe traders gain by quickly recognizing an opportunity, seizing it and just as quickly exiting. Return is a function of the speed and range of the day's internal movements. So is risk. A quantitative measure of risk in the day timeframe evaluates average swing size. Some swings are more risky to trade than others. At the other extreme, some markets are so un- risky that their opportunity is unacceptably small to the day trader. One of the capabilities of Auction Market Theory is to explore and quantize this aspect of auction markets.

10) Serial Correlation and Forecasting
There is little day-to-day serial correlation in auction markets (see e.g. Speculation, Hedging ..., Labys & Granger, 1970; or reference 4, p19). This makes today's trading a poor predictor for tomorrow. Consequently, it would be a questionable aim of a market theory to propose forecasting market behavior. AMT trading is based on understanding the current market situation and having a strategy for change; not predicting "tomorrow's" price.

11) Members Functions
So far market knowledge is equated to an understanding of value based data displays. A market is also comprised of people, the public and the members and/or professional traders. Four classes of futures members inhabit the floor. Non-members must interact with them. It is to the public's advantage to understand member's motivation. Class 1 are the Locals or scalpers, the other side of virtually every transaction. They work for themselves, provide liquidity and are most comfortable with balanced markets. Class 2 are the commercials who's job is to trade and hedge for their companies. These are the businessmen of the floor. Their company will be a large commercial firm, e.g. Morgan Stanley. Since commercials know both the cash and futures markets, they are the best informed traders on the floor. They too work best in balanced markets. In addition to their "business" they may speculate when prices are out of line (capping). Commercials typically do five to fifteen percent of the volume. Class 3 are members clearing for other, off-floor, members. This class accounts for around five to ten percent of the volume. Lastly, Class 4 clears for us, the public. We, the public, are typically twenty to thirty percent of the day's trading volume. Chicago Board of Trade and Chicago Mercantile Exchange release the Liquidity Data Bank reports with volume-price-member type statistics.

12) Electronic Trading Platforms
Electronic platforms are developed primarily to cut trading costs. A side effect is that trades clear faster and more accurately. Member - public interactions are minimized. In some cases simultaneous trading occurs on the floor and on the electronic market. At this time, many traders are placing orders electronically through their computers but the trades are still routed to a trading desk and pass through the standard floor procedures. While how a trade is accomplished is of little moment theoretically; practically there can be a big difference in costs.

As electronic trading grows, the influence of floor members will diminish. The current effects of exchange trading hours will no doubt diminish as well. These changes will little affect the fundamental characteristics of auction markets. Most likely, a trader familiar with auction market basics will have minimal trouble incorporating such changes. For instance, if opens and closes disappear entirely, a new timeframe to replace the exchange day will become apparent, probably defined by trading volume. Currently, the 24 hour electronic markets show consistent times of higher volume tied into the market being traded.

13) Markets Cycle
Markets continually move from balance to testing the balance, to trend, to testing for end of trend and back to balance. The time spent in any one phase may be long or short. There is no valid method of predicting when the phase may change. Further, any phase may be arbitrarily short. The change from balance to trend can occur in minutes or may take days of testing the balance. The progression is known: a market in balance today will surely break out in the future.


Many markets do not report volume along with the price ticks. In fact, some markets never report volume at price, just end of day totals for all prices. A surogate for volume (demand) is price over time.
Practically, TPOs greatly simplify defining market structure within the trading day.
Price-over-time, in line with general usage, is designated value. Value maps out a wide area in the mid region of a balanced market.

Hi MzVega,

Unless one knows the theory, it is hard to apply and make use of the tool. This is what is understood after seeing much of Dalton's videos.

Looking forward to your posts with much eager.

Thanks.

AMT and CAPM Contrasted
A general Auction Market Theory would include AMT in the day time frame, CAPM in the year time frame and an as yet unspecified intermediate time frame theory joining the two. Such a theory would cover all financial auction markets. Insofar as CAPM is concerned, AMT fills a missing element, disequilibrium. All portfolios and changes specified by CAPM are constructed in the near timeframe. That is, at some point one must buy and/or sell the individual instruments in a portfolio. AMT can augment CAPM in the near term decision of timing a portfolio change. Hedge funds ideally use both CAPM and AMT principles. The point is that AMT adds near term information. It is just this near term information that the trader uses for trading.

CAPM is a tool for investment professionals, but some of it's aura has filtered down to the public. Investment firms have spread the word of their sophisticated market analytical tools and sell mutual funds on that basis. CAPM concepts are of little value to the day trader. AMT is designed for day trading. It is of incidental use to investors. The two are related as noted, but have more differences than similarities.

Capital Market Theory vs Auction Market Theory
Possibly the largest difficulty investors entering the day trading arena face is assuming that day trading is similar to investing. This is emphatically not the case. The day trader has the potential to generate far larger returns than available in investing. But the risk is much, much larger and the environment, the rules of engagement, is far different.

Technical Analysis (TA). An Example
While there is no theory competing with AMT for market analysis, a great deal of effort continues to go into Technical Analysis (TA).

TA is price based market research focused on 'indicators'. There are hundreds of books on TA techniques and well over 100,000 traders have databases and TA analysis programs. How does TA differ from AMT? The difference is simple but profound. TA uses price based analysis* (this includes volume at price histogram "volume profile") (all prices treated equally), AMT is based on value (all prices are not equally valued).

If TA were an effective methodology for the trader, it would be easy to say that TA and AMT were just two different ways of looking at the market. However, most traders do use TA and it is estimated that over 90 percent of futures traders lose (recent surveys of equities day traders appear to show the same result). Consequently, the newer methodology, AMT based, may offer traders an advantage. At the least, AMT has a sound theoretical foundation, whereas TA does not. With AMT, one can look inside the market to divine what is happening and why, with TA, one cannot.

The difference between TA and AMT can be illustrated easily. A popular TA model is Japanese Candlesticks,. In the example below we first show a Market Profile and compare it to a Japanese Candlestick for the same day.

TRADING DATE: 30 DEC 99 CONTRACT: MAR 00 SOYBEANS (CBOT) (S H)
TRADING BEGINS 0930 (CST); CLOSES 1315; TPO SYMBOLS ARE DEFGHIJK


4710 I
4706 I
4704 HI
4702 HI <= Value Area Upper
4700 FGHI
4696 FGHI
4694 FGHI
4692 FGHI
4690 DFGHI
4686 DEFHI close
4684 DEFI
4682 DEF
4680 DEF <= Value Area Lower
4676 DE
4674 DE
4672 DE
4670 DE
4666 D
4664 D
4662 D
4660 D
4654 D open
4652 D
4650 D

Price ranged from 471:0 to 465:0. Value Area is 470:2 to
468:0. Center of the day's distribution is 468:6. Relative volume
is in the letters, the TPO's. There was five times the volume at 468:6
as at 471:0 or 465:0.
A brief analysis of the market from the profile:
1) The open was quickly rejected by the market
2) The Low was immediately rejected by the market
3) Price traded most of the day within the value area 4702 - 4680
4) The high at 4710 was immediately rejected by the market
It is clear that the market accepted (as value) prices in the 4702 to 4680 range and did not highly value prices outside that range. Normally, one would combine this and earlier Market Profiles into an Overlay, getting market condition. From that point, one would analyze the market and obtain trading information as in the trading strategy example above. For now, it is enough to simply read the market from the profile and compare that information with the candlestick.

In the Japanese Candlesticks technical method, the basic element is a cylinder with open and close as limits; with the high and low spiking above and below the open/close base. The candlestick form for the Market Profile above looks like:

| high 471:0

|

----- close 468:6

| |

| |

| |

----- open 465:4

|

|

| low 465:0

Candlestick representation of above profile.
The prices most utilized by Candlesticks, the high and low, are just the ones least valued (traded the least) by the market. Likewise, the open, in this case, was also quickly rejected, but was used by Candlesticks to form a base.

As with the Market Profile, Candlesticks would combine this day with others to develop trading decisions. Value is important, as we have shown. Consequently, Candlesticks is using poor, non-representative data in their construction. Every day's high and low are those prices least valued by the market. Trading decisions taken on the basis of poor data are unlikely to prove to be good predictiors of the market's future path or even provide a reasonable picture of the current market situation

Noise Traders, A Brief Review

By Donald L. Jones, CISCO Futures
April 9, 2004

Introduction
Financial economists identify two classes of traders, the "informed" and "uninformed". Informed traders are presumed to understand the market's basics and arrive at value by standard principles (knowledge of interest rates and dividends, insider information, etc.). Uninformed traders, also called "noise traders" by economists, use market activity for trading decisions.

What is an Informed Trader?
Informed trader is a euphemism for insider. It is one who has some specialized information to act on. In equities, the inside information may be specific (company ABC is near bankruptcy) or the insider may be particularly good at understanding company filings. In futures, the insider may know of pending large contracts for grain, etc. Usually an informed trader is a professional working for a Wall Street type firm. Informed traders tend to trade heavily on their information, which is often, but not always, correct. Informed traders often are identified as the "rational investor" so beloved by economists. Incidentally, most brokers are not insiders, although the uninformed trader is often led to believe that they are. Some firms even forbid their brokers to trade at all.

What Is an Uninformed (Noise) Trader?
In the references below, noise traders are variously described as:
1) Individuals who trade on what they think is information but in fact is merely noise, such as "market indicators". They buy and sell on grounds that are unrelated to the larger movements of the market, although they believe the 'information' they have is relevant.
2) One who doesn't have any special information but trades for exogenous reasons; e.g., to raise cash. These traders are active, making a market for others; they provide someone to exchange with, i.e. they increase market liquidity.
3) In periods of high volatility a large fraction of agents (traders) are in the noise group (some normally informed traders become uninformed).
4) Small speculators rely on nonfundamental information, thus they are noise traders.
5) Noise traders are more aggressive on average than informed traders and necessarily, a new generation arrives each trading period.

A typical composite noise trader is 1) a small speculator, 2) who has no special (fundamental/inside) information, 3) who's trading increases volatility and 4) may be a chartist, a technical analyst, a trend follower, etc. Further, the odds are against noise traders because informed traders are often right and the noise trader is on the other side of the transaction.

It is arguable that all traders are noise traders at times since there is no demonstration that the correct fundamental value of a market can be found, although truly insider information almost always works. Some nominally "informed traders", like mutual funds that rotate their portfolios regularly, typically do worse than the market index. So they too, often seem to be noise traders. Research has shown that in times of high volatility some normally informed traders slip into the uninformed ranks.

Fate of the Uninformed Trader
Is the small speculator doomed? Many are because they stubbornly believe they can predict the market. They are buoyed by their trading successes, believing these derive from their knowledge or methodology. Losses to them just means they have more work to do. In reality, a noise trader with a fifty - fifty chance of winning on each trade can have a string of successes strictly from the statistics. In the long run most uninformed traders lose, and as noted in 5) above are replaced by new recruits. A small percentage continue to survive because they have developed a good knowledge of the market and follow good trading habits.

Hope for the Uninformed Trader
Can the small speculator become an informed trader? Surprisingly, yes. The informed trader is one with a good grip on value. It follows that any trader can become informed by finding the current market value of a stock or commodity. Current value is rarely the long term value of the fundamentalist; rather it is the value perceived by the current market. Today's value defines the price region the bulk of the traders see as fair

Now I could perceive value more clearly MzVega.

Tick volume at price, is “at price” data,

AMVT does not use any “at price” data for analysis. Any analysis that uses at price data is TA. It does not belong to Auction Market Theory. Its not an allowed practice. Read up on the subject. I posted the article explaining why…………

Again, you fail miserably, the people who defend such “ass backward” statements can never provide a book & page reference explaining & showing one example any of authors using “tick volume” data at all for analysis. Show me one example from any of the books, that explains “how” they use volume at price data. Show me what they do with “volume at price”. Give me a book & page #, showing how they use the volume data. I provided my references………………..and again you fail.

I’ve yet to meet a volume profiler who can. Show me from one of the Authors books, “how” they actually use volume. Find a page example that explains how to use “volume at price” and it’s context.

We’ve read the same books, show me where the author explains exactly “how” volume is used. I don’t want to see the “word” volume, I want you to give us the book & page # where it explains “how” to use it in the context it’s explained…..(any of the books will do)
Show us an example in the book where it explains what to “do” with the volume at price data. What does the Book say? Provide the “context” in which volume data is used.

You need to provide more than just a sentence that contains the word “volume”. If you read the first post, it says you need to provide a book & page reference to support your argument.

Again, Im wasting my time here, you will never be able to provide, a book & page reference that supports you’re argument. (there isn’t one) Just because you “hear” the word volume, doesn’t mean you understand the “Context”, in which its used.

You refuse to educate yourself, by reading the books written by the author himself that explains the definition and its use. If you refuse to read the definition or the context in which volume is used in the authors own words……. There’s nothing to discuss or debate.
Please do not post without providing book & page # that supports your argument. Or better prove to us you’ve actually read something from Dalton book, and show us in his own words, what his does with volume. Again not just a sentence with “word” volume in it, we want to read exactly what he does with volume at price.

Again, please do not continue to post, without facts that support your argument……………..

In any field of endeavor, preparation shows up in the results. Nowhere is this more true than in futures trading. The average public speculator has little knowledge of the structure of the futures market and the regulations that govern. It shows: the odds against the outside trader are large; reportedly some eighty five percent of outsiders fail. In our experience, the failures are characterized by a lack of understanding of how the market functions. Trading is a profession. It requires preparation and practice. Ignorance of the market environment usually leads to abuse of leverage (overtrading). Most (public) traders want to trade now and learn later, implicitly relying on luck to stay out of trouble.

In the long run, it is not luck that makes winners. Winners understand the markets and how to find and use an edge. Jack Schwager's books, Market Wizards I & II detail many who succeeded, including Richard Dennis who reputedly turned $400 into a $200 million fortune.

Not only does most of the public not really understand how the markets work, but their whole approach is wrong. They seek out a methodology for market prediction and inevitably are drawn into 'Technical Analysis'. They find themselves developing databases, buying technical analysis software and losing, losing, losing. Something is wrong when so many intelligent people find it impossible to master trading. The root of the problem very likely lies in the methodology, Technical Analysis. The input data (ticks, and daily prices) are not amenable to tracking value and value changes. For that one needs Auction Market Data.

Auction Market Analysis differs greatly from Technical Analysis. The difference is simple but profound: Technical Analysis deals with price; Auction Market Analysis works with value. If you know value and it's history you can know in depth what the market is doing (market condition). If you know only price and it's history you can see where the market has been, but you know little about it's current condition. Value is in-depth knowledge, price is superficial.


Oftentimes Technical Analysis uses exactly the wrong information: in the popular candlesticks display the body is made of the open and close while spikes on the top and bottom are the high and low. Highs and lows are used for decision making. But we know from the Market Profile that the highs and lows are the excess points that rarely have much to do with value! The same argument can be made against Pivot Points and most other technical analysis methodologies. They use price, not value, to analyze markets. There are well over 100,000 traders who maintain price databases capable of optimizing trading models based on price. There are a lot of people competing against each other using a shaky premise for trading decisions. Most lose!

Economists put traders in two categories, informed and uninformed. The informed class are the are the professionals, the insiders. The uninformed, those without any inside knowledge or contacts are termed 'noise traders'. Your "inside" information is your knowledge of value.

The basic, underlying theme of Auction Market Analysis is that if you understand your market and the roles of the participants, you will have the information upon which to base rational, low-risk trading decisions. You can know what a market is doing by monitoring the 'market generated' data it develops..

Market generated data combines price, time and participation by the four types of exchange members (floor, commercial, off-floor and public). How well you unwind this information from the data determines how much you can learn about the market. That is, who is doing what, and where they are doing it. Trading the market is a business!! The key to your trading success lies in understanding the ins and outs of trading as you would in any other profession!

Trading is real world. Keep in mind that in describing markets we use mathematical algorithms that use reported market data (e.g. the Value Area of the Market Profile). Market data is often messy with variations or errors that sometimes can outsmart even refined algorithms. Exceptional trading days often put a strain on exchange reporting. You must learn to exercise judgment when you see data "that just cannot be right" or if it is totally missing.

Since no one will step up and show where exactly in "value based power trading" does it explain "how" to use volume.

"Again, the word "volume" doesn't explain its "context"

How volume is used in MP analysis and the context in which it's used
So here is Chapter 2 of Value Based Power Trading, it shows "what" kind of volume is used in MP analysis and "how" you use it. Read it before you tell me that you can use tick volume to accomplish the same thing. And it also explains what data you use to accomplish the same analysis, when volume isn't reported. Again tick volume is not used.....................

Tick volume at price isn't used as a variable anywhere! It has nothing to do with AMVT or MP. "tick volume" has nothing to do at all with AMVT or MP. No one will show me where, in any of the books it does. I can show you how it's used. And if you see how volume is used, you'll see tick volume is not th correct volume data needed for MP analysis................................

How volume is used in MP analysis and the context in which it's used see PDF

It doesn't say that "tick volume at price" is used as a proxy, TPO's are...............................

Hi MzVega,

Hope you will continue posting amidst the volume thing. Looking forward to your posts and to learn MP analysis.

Prem

Fundamental and Technical Analysis
Short time frame trading has long endured the fundamental versus technical controversy. Fundamentalists seek to predict the 'proper' value of an instrument from basic economics. Their tools are reports of economic variables that are believed to affect the value of the instrument. Interest rates, production and consumption rates, unemployment reports, etc. are factored into their calculations. Typically, thirty or more variables can be easily accessed. Once value is determined, buying or selling is indicated, determined by current market pricing.

Technicians use charts, formulae for moving averages, oscillators, relative strength and so forth to develop 'indicators'. A technician's implicit assumption is "the market speaks through price". Fundamentalist's problems are 1) maybe the most important variable is not known and hence not included, 2) even if all significant variables are known the weightings may be incorrect and 3) assuming the correctness of the analysis, still the psychology of the market may keep prices away from the calculated values. Technicians suffer from 1) the ability to calculate hundreds of indicators and the problem of which to follow (the paralysis of analysis) and 2) reliance on the wrong data for the job (see the appendix on Technical Analysis). Most traders cannot perform the fundamentalist's tasks adequately. Most traders can perform technical analysis by purchasing sets of programs and data bases.

AMT is neither Fundamental nor Technical according to the descriptions above. Like the technicians, AMT uses market generated data. Like the fundamentalists, AMT calculates value. However, the data used by AMT differs from that of the technicians. The value calculated by AMT has little to do with "what the value should be" of the fundamentalists. AMT value is "what the market says it is". The similarities between AMT and technicians/fundamentalists are minor, the differences profound.

AMT requires that each instrument in the market (futures, equities, etc.) be monitored separately. There is no general index that characterizes overall auction markets, since the driving forces for the individuals are, in the short term, unique to themselves. Within a market one may find trading opportunities anywhere and at any time. The U.S. futures markets average 75 trading candidates daily. About 40 percent of that 75 trade. Selecting viable trades hinges in part on the trader's risk capital, appetite for risk and judgement. Risk in trading deals with the potential for ruin, quite unlike risk in equities. There are straightforward formulae that specify the proper trading risk, given one's trading history (win/loss ratio and winning gains/losses ratio).

Auction Market Theory permits development of other controls that can significantly affect the trader's bottom line. A most important measure is the theoretical reward to risk ratio (R/R). A requirement is for a standardized trading model to sample the rewards and risks for historical trades on a given instrument. Based on trading statistics (actual or theoretical) the average reward to risk ratio, R/R, identifies the current profit potential of a trading instrument. A study of trading data shows variations of up to a factor of ten in R/R. Thus, the R/R factor plays a strong role in selecting the best risk. Maximizing R/R is a concept similar to the 'Efficient Portfolio' of CAPM. In each case, one seeks to select the optimum situation for the job; thus minimizing risk and maximizing return.

Theory as it applies to Auction Markets
Theories are often thought to be incomplete without the ability to make predictions. This is not so. At base, a theory is an explanation of a phenomenon. A thorough understanding of the phenomena may well lead to the ability to predict at some level. However, the feedback nature of a complex market may preclude an ability to develop lasting predictions. For example, if the theory were found to predict tomorrow's price, everyone would soon learn and the feedback would adjust the market to make the prediction fail. This is obvious in futures markets which are essentially zero sum (in the absence of transaction costs).

Predictions that do not directly bear on profiting from trading are not disallowed. A study of the persistence of trends found that a mature market experiencing a new high price had an eighty percent probability of reaching a yet higher high within ten days. This finding illustrated that the market had momentum under certain conditions, a feature not allowed in efficient markets.

The complex nature of the market is a strong argument for a phenomenological approach to market theory. A market has many facets, elements that are functional parts, but still with a large degree of independence in their behavior. As one of these elements changes, that changed behavior is returned to the market via the feedback mechanism. While elements such as volume, volatility, range, time behavior and the like are individually measureable, they all combine to form the market one studies or trades. Each element must be discovered and studied on its own before there is any thought of considering how it affects the whole. The vital question of extreme market behavior such as large, fast changes in value, must be understood. It is the thesis of Auction Market Value Theory that each of the market elements can be isolated and must be understood prior to forming a coherent description of a market. The experienced trader collects all the market information available, assesses each piece, ending with an understanding of the market situation. Not all pieces are necessarily needed to find the market's condition. Different sets will be used at different times.

As an analogy, think of a homicide detective. Experience has taught that there is a wide variety of clues. Arriving at a crime scene, the detective collects all clues available. Many clues are irrelevant and are later discarded. The pertinent clues lead to a solution of the crime. At the next crime scene, again all clues are collected. Again, the irrelevant clues are discarded, except this time it is a different set of clues that are irrelevant. If you were to suggest to the detective that to save time only the relative clues be collected, you would be laughed at: which clues are relative becomes known only through the discovery process of the crime investigation.

A crime scene is a complex situation in real life. The perpetrator seeks concealment, hiding or leaving misleading information. It is the detective's job to uncover the truth. The real world of the auction market is merely another a complex process with many clues of varying utility at various times.

Auction theory has the goal of understanding the current market situation. Is the market balancing, trending or behaving in some other way? Obviously if one can understand the current market condition it was possible to understand the condition at an earlier time. Comparing the current with the earlier condition allows one to see if the market has changed.

A combination of the relevent market elements will lead to the conclusion that the market is behaving essentially as it was at the prior determination or it has changed. No change means continuation. If the market was trending the trend continues. Or if the market was congesting, it still is.

Change or continuation provides the basis for market decision. For instance, a trader can find opportunity in change. A conclusion that the market is changing out of a balance condition may lead to a decision to trade. A change from moving (trend) into balance is an argument to exit from a trade. In the case of a portfolio update the old equities should be eliminated in a balance or change to downtrend situation. The new equities should be bought into the portfolio when they are in balance or trending up. If they are in a downtrend, it clearly makes sense to wait until the downward move is over before purchasing them.

To the analyst/trader it all boils down to a determination of change or continuation. Another way to state this is to couch it as a search for the unexpected. If a market has been in equilibrium, it is expected that it will continue in equilibrium. If a market is trending, it is expected to continue. Change is the unexpected. One way or the other, an analyst/trader must search for the unexpected. The expected, the market condition (e.g. balancing or in equilibrium) must be known. The only way to find a market's condition is through empirical measurements. Sharpe, in Ref 1, pg viii, decries empirical studies, stating they have a "short half-life". In the absence of an over-arching theory like the normal distribution of CAPM, complex market analysis must rely on empirical measurements.

Looking forward to your analysis to identify change and what variables (reference points) to look out for and in what context.

Thanks.

Mind over Markets Chapter 3 pg. 33-........

Tunnel vision is an easy trap to fall into, especially when learning large amounts of new information, It is not uncommon to hear beginning Market Profile traders comment, "The Profile doesn't work." There is nothing about the Profile that does or does not work. It is only a passive gauge of market-generated information—a way to organize the data, much like the musical score. What fails to work is the trader's ability to see the "big picture" objectively and realize that everything is a series of facts surrounded by other circumstances. Only when all the circumstances are interpreted together will successful trading occur.

Building the Framework

The Big Picture: Market Structure, Trading Logic, and Time

The "big picture" is made up of three broad categories of information: market structure, trading logic, and time. As a novice you learned the basics of market structure, the most tangible information offered by the Market Profile in the unique bell curve graphic. Very short-term structure is reflected through TPOs and the marker's half-hour auctions. We can see, measure, and name the physical aspects of the Profile. By the day's end, structure shows not only what happened, but also when it happened and who was involved. In short, market structure provides visible evidence of the actions and behavior of the market's participants. In this section, this structural evidence will be built upon and combined with time and trading logic.

Time is the market's regulator. In its broadest sense, time sets limitations on the day's trading by imposing a certain framework, i.e., the number of hours from the open to the close. Most traders see time only in its function of the "closing bell," and do not consider its influence on price and opportunity. Without considering time, there is no way to judge value, and trading becomes a 50-50 gamble on price movement.

In the day timeframe, time validates price. The areas of the Market Profile's bell curve showing the greatest depth indicate the prices where trading spent the most time, thus establishing value for that day (price x time = value). Understanding value and value area will become more and more important

Time also regulates opportunity. Consider an everyday life example. You are in the market to buy a pair of snow skis. You shop around long enough to get a good feel as to how much skis normally cost or what you consider value. You don't need the skis right away, so you wait for a chance to buy them under value—you are a long term buyer.

You know that after the ski season ends, most stores will have "summer ski clearance sales," when price will temporarily drop below value. You also know that these prices will not last long, for time regulates opportunity. The stores could not afford to sell at such low prices all year and still make a profit. They are merely clearing excess inventory in preparation for new stock. To take advantage of the low price, you must act quickly.

The same principle is true in the futures market. Good opportunities to buy below value or sell above value will not last long, for price will move quickly with increased competition. If price stays below value for a long time, for example, it is no longer a good opportunity. Something has changed, and value is being accepted lower.

The third and most difficult category is trading logic. Trading logic is largely a product of experience, but it is more than just careful observation and practice; it is an understanding of why the market behaves the way it does. This understanding is best gained over time and through a conscious effort to understand the forces behind market movement. Certain aspects of trading logic can be taught in relation to structure and time, by derivative learning. For example, you know that a tail is an indicator of strong other timeframe activity on the extremes. If the tail is "taken out" by a price rotation back into the tail and TPOs build over time, trading logic says that something has changed, and the other timeframe buyer or seller that moved price quickly is no longer present or is less willing to respond to the same price levels.

The only way to really understand the market and its logic is to observe, interpret, and trade. Remember, much learning does not teach understanding.

A Synthesis: Structure, Time, and Logic
Imagine two children, each racing to complete a giant jig-saw puzzle. Both are working on the same puzzle with an equal number of pieces (the same structure), but one child has a picture of the finished puzzle and one does not. Obviously, the child with a knowledge of the whole picture will finish first.

The Profile graphic is much like an intricate puzzle. Its structure reveals more and more as the day nears completion. But, like the child with a picture of the finished puzzle, traders with an understanding of the "big picture''—those that can see the market develop before it is revealed by structure—are generally the first to put together the pieces of the market. Market time and trading logic are the two big picture components of a whole market understanding. Only through a synthesis of all three components will a trader successfully put together the puzzle.
We will now discuss market structure, time, and trading logic according to five general criteria:

1. Ease of Learning
2. Amount of Information
3. Recognition Speed
4. Trade Location
5. Confidence Level

Ease of Learning Ironically, the order in which structure, time, and logic are usually learned is opposite from their order of occurrence in the marketplace—not because they are taught incorrectly, rather, because market structure is learned more quickly and easily than the roles of time and logic. Market structure is the finished product, and it is always easier to see the finished product than to identify the stages of its assembly. Mastering market structure is largely a matter of successfully recognizing and interpreting the Profile graphic. Understanding the role of time, however, requires a much deeper understanding of the market's auction process. Trading logic is the hardest to learn, particularly from a book or instructor, for logic is the ultimate outcome of trading practice and experience. Trading logic is the raw human instinct of the marketplace. True trading logic comes only through intensive participation and careful examination of real market situations.

Amount of Information While market structure is clearly the most tangible information offered by the Profile, it also contains the greatest amount and variety of information. Why, then, is it so difficult to interpret market structure in real trading situations? The difficulty lies in recognizing what is transpiring as the structures are building. The inability to identify a developing structure does not necessarily mean that the information is lacking. It is simply not conveyed in an easily readable format. In addition, it is possible to monitor the wrong information. Market time and trading logic provide very little in terms of visible, tangible information—but the information is in the market. Successful trading requires the ability to find and interpret the more subtle clues found in time and logic, and integrate them with the structure.

Recognition Speed It takes time to build structure. Thus, while the Profile structure reveals a lot, the sheer fact that time must transpire suggests in the market that fundamental changes occur before they are revealed by structure. Structure acts as the market's translator, and translated information is second-hand information. The market has already spoken in the form of time and logic. Traders who rely exclusively on structure without integrating time and logic will be late in entering and exiting the market, just as catcher who holds his throw until he sees how fast a man stealing second base can run will never make the out.

Trade Location Later recognition leads to later entry and exit, which in turn leads to less desirable trade location. For example, range extension (structure) confirms that other timeframe buyers have entered the market. But when did they enter the market? If we rely solely on structure, we do not realize the other timeframe buyer's point of entry until the point of range extension, that is, when price is on the day's high. Buying the high results in poor day timeframe trade location, at least temporarily. In many cases, it is possible to know that buyers are assuming control before the actual structural confirmation (range extension) through an understanding of market time and trading logic.

Confidence Level Trading based on structure provides the greatest level of comfort and confidence, for there is obvious proof on which to base a decision. The more information we have in our favor, the more comfortable we are with a trade. Unfortunately, visible information and opportunity are inversely related. The more structural information present, the less an opportunity still exists. Thus, if a trader waits for too much information, chances are good that has been missed. If all the evidence is present and visible, then you are far from the first to have acted on it and the real opportunity probably have poor trade location. Market time, followed by trading logic, provides the least amount of visible evidence. To the advanced beginner trader, trades based on time and logic offer a lower level of confidence, for the trader is not yet comfortable outside the realm of structure. Seasoned traders with a whole market understanding, on the other hand, trade using logic and time and then monitor activity for the additional information (structure) necessary to increase their confidence in the trade.

Summary: Logic creates the impetus, time generates the signal, and structure provides the confirmation.

Market Profile is best known for the Profile graphic, or structure, experience has shown that understanding the influence of time and trading logic is more important to reaching a holistic view (pattern recognition) of the marketplace. Putting in the extra effort to fully understand the building blocks of structure—market time and trading logic-—will better prepare traders to anticipate and take advantage of trading opportunities as they develop, not after they have passed.

Evaluating Other Timeframe Control
We have stressed in general terms the importance of determining who, if anyone, is in control of the market. Evaluating other timeframe control the elements that signify other timeframe control are perhaps the most deceptive of all market-generated information we will cover. Often, information that we believe we are interpreting objectively is presented in such a way that its actual nature is misinterpreted.

An example of such an "illusion" often occurs when a market opens exceptionally above the previous day's value area. The other timeframe seller responds to the higher open, enters the market aggressively and auctions price lower all day. However, at the conclusion of the trading session, the day's value is ultimately higher. In the day timeframe, other timeframe sellers dominated the marker's auctions through their attempts to return price to previously accepted value. But the responsive selling was not strong enough to completely overpower the higher opening triggered by a strong other timeframe buyer. Day timeframe structure indicated weakness, while the market was actually very strong in the longer term.

As illusions go, the preceding example is relatively easy to detect and evaluate. Unfortunately, the information generated by the market is not always so clear. In most cases, a more analytical approach is needed to effectively gauge who is winning the battle for control between the other timeframe buyer and seller.

To evaluate other timeframe control we will examine range extension, tails, and activity occurring in the "body" of the Profile, and value area placement in relationship to the previous day. These factors determine whether the participants are acting on their own initiative or are willing to act only in response to an advantageous market movement. Another timeframe participant who acts on his own initiative is usually more determined than one who merely "responds" to a beneficial opportunity.

Who has control in the day timeframe? The ability to process information via the Profile structures enables a trader to recognize attractive day timeframe trades. Longer-term traders must also be able to read and interpret day timeframe structure, for a longer-term auction is simply a series of day auctions moving through time. Longer-term auction evaluation and value area placement requires far more analysis. We mention it here to avoid creating the illusion that day timeframe control is all-conclusive— it merely reflects activity occurring during one day in the life of a longer-term auction.

Learning to read and interpret day timeframe structure is beneficial to all market participants at one time or another. This understanding most obviously influences the individual who trades only in the day timeframe, in other words, one who begins and ends each day with no position. However, all longer-term traders are also day traders on theday that they initiate or exit a trade. The concept of longer timeframeparticipation in the day timeframe is best expressed through two examples.

Imagine a food company that purchases a large amount of corn for its cereal processing plant. The food processor has an opinion that com prices will rise but also wants to be appropriately hedged against loss. Thus, as the price of corn rises, the company gradually sells grain futures against its inventory, in effect "scaling in" a hedge. On one particular morning, corn opens far above the previous day's value, but early Profile structure indicates weakness. The processor takes advantage of the higher open and expands the size of its hedge (by selling more futures).

However, as price auctions lower over the course of the day, the processor may partially close out its shorts, seeking to replace them later at higher prices. The food company's hedging goals are clearly longer term. However, when the market created an opportunity in the day timeframe, the food company elected to "trade" a portion of the hedge.

In a second example, a futures fund manager with a bullish bias may elect to "trade around" his long-term positions by taking advantage of day timeframe structure. If market structure indicates that the market is likely to break, he may sell a percentage of his position, reestablishing it later in the day. In fact, if there is enough volatility in the market, he may reposition a portion of his inventory more than once on the same day.

Other Timeframe Control in the Body of the Profile
The role of the larger institutions and commercial participants in the marketplace is much greater than merely seeking to take advantage of price as it moves away from value (evidenced by tails and range extension). Many of the longer-term commercial users of the futures exchange have a certain amount of business they must conduct every day. For example, General Mills must put boxes of cereal on millions of breakfast tables every morning. Therefore, they are constantly in the market as part of their daily business.

This more subtle, involuntary other timeframe activity generally takes place within the body of the Profile. Nonetheless, it plays an important part in our evaluation of the competition that goes on between the other timeframe body of the day's Profile participants. The TPO count provides a means of measuring the activity of the other timeframe within the body of the day’s profile.