Market Profile, Order-flow, Footprint - Demystified - Part 1

It's been close to a month since I started my trading room, and the response has not been bad I must say, close to 116 members and counting. To me more than the numbers what matters is the collective wisdom which is both created and transferred among members, more so because trading esp. the way retail traders operate, is a very lonely business and one has to find like minded people to work with. So on these fronts, I am pretty happy with the way things are progressing. Oops, I think I went on a tangent.

Coming to the topic, incidentally two members in the room asked me

a) Why I don't use Footprint charts? Wouldn't it give us better entries and exits? 

b) Why I don't you use Market Profile? Isn't it better to look at the markets from that perspective?

Two more members didn't ask me, but told me something

a) I was in a room where they claimed to use Market Profile/Orderflow and Footprint charts, but I lost 30% of my capital by following their trades, I hope your system is better.

b) I was a in room where they claimed they tracked "Smart Money" - But I didn't see any value in it in terms of their win rates.

That made me realize people really need to be educated about what this whole thing is. All these things are becoming some sort of "Snake Oil" to be honest.

Lets start with what is Market Profile.

There was this guy by the named Peter J. Steidmayer who was a trader at CBOT, and later had a management position as well at the exchange. He developed this approach to view the markets, in the form of a normal distribution. As you can see below, the middle area is the area where 70% of trade happened. 

 

Next he developed a way of representing Time, Price and Value - "Value" here means the price region where more than 70% of trades happened.  

Then there are concepts like POC - Point of control, POC represents, as you can see above, the the price at which trading happened for the max duration of time. VPOC is slightly different but related concept from Volume Profile, its the price at which max volume was traded for a given time frame. We will refer to Volume Profile at the end.

He also defined certain day types based on how prices get distributed on a given day. 

http://www.marketcalls.in/market-profile/market-profile-different-types-of-profile-days.html

The link does a good job of explaining, the concept of day types. At a very basic level what it means is if the day was Trending, Range Bound etc. with reference to something called IB - Initial Balance which is defined as the range of the first 30 mins or 1 hour.

So if the price keep holding above IB it obviously means buyers are in control and visa versa if price keeps below IB. I like these concepts, IB, Open Drive types etc. But they need to be tested for specific markets. So from a perspective of looking at the markets its good to use some of these concepts.

Now coming to the other two things Orderflow and Footprint

Orderflow - The interaction between the buy orders and sell orders and the price discovery at a given moment - Which happens with the combination of limit and market orders.

http://optimusfutures.com/tradeblog/archives/order-flow-fundamentals/

Read the above link irrespective of whether you are interested in the blog post or not, its very important for any trader to understand how and why price moves happen. But the bottom line is, a visual representation of orderflow is called Footprint/Number bars, depending on the company/software provider.

Below is an example of how it looks like

So how your next question would be how is Market Profile connected with Orderflow/Footprint Charts? - The short answer is they need not be connected.

You can trade with just Market Profile concepts and Profile charts like the one below, but it makes more sense only on time frames larger than 30 mins. Below is a day wise profile. But as you can see its not really intuitive to trade based on this, its good for post facto analysis though.

Now let me confuse you a bit more, by adding one more concept - with the advent of Internet and the easy access to volume data, a related field of Volume Profile and a lot of volume based indicators came into existence. The below chart gives you both Market Profile and Volume profile in the same view. You get to see the price at which the max volume was traded as a profile (VPOC), you can also get to see Cumulative Delta Divergences another interesting volume based indicator - https://marketdelta.com/delta-divergence-chart-signals/ 

Now, each of these things, Market Profile, Orderflow Charts, and Volume Profile can be used in combination or by themselves to make a trading decision. You can mix them up and create your own system based on a combination. 

In the next part I will share my perspective on the practical use of these tools. The key is - Do they have any predictive capabilities? 

Think about it, will see you with the next post soon.

You can read the posts here and here.