Auction Market Theory

Market Profile, Order-flow, Footprint - Demystified - Part 2

In the previous part - here - - We got an overview of what these concepts are and how they fit in together.

Now in the part 2 - I am going put together my views on the relevance of these tools, in the context of Intraday trading and Scalping.

Does following the market profile concepts like POC, VPOC, IB, VAH, VAL give you an edge in your trading?

In all fairness, I must say conceptually these make sense, but are of no value in the context of trading decisions if you do not have back-tested probabilities to work with. In other words these things make for good reference values, but that does not help in trading. What you need is probabilities off the references. For example you need to know - % of time POC acts as a support, or once the price crosses IB, you get an extension of y points more than 70% of times. So bottom line, no back-tested probabilities, no use of these concepts.

Does following the ORDER FLOW / FOOTPRINT give you an edge in your trading?

This is a difficult question to answer, it has several parts to it

a) Quality of Data Feed - Like all other things in data analysis, garbage in is garbage out - Though you may have the best of the charting software, if the data feed sends garbage to it, its not going to be of any value. That is one reason, if you compare two foot print charts with data feeds from two different vendors, you should not be surprised to see different data in both the charts. Then there is a larger issue of the quality and nature of the data that the exchange shares with these data feed providers, this is where protocols like ITCH and OUCH come into picture, without which your order-flow becomes less reliable. I seriously doubt if NSE provides such granular data. Read the excerpt below from the book  - Machine Trading: Deploying Computer Algorithms to Conquer the Markets - by Ernest P. Chan

b) Back-testing Order-flow Data - Again, you need some references to work with even if you have Orderflow, for instance any buyer of greater than x size leads the trend by y %. This back-testing, is not easy at all given the quality of data that we have. As shared in the excerpt above.

c) Smart money & Orderflow - This one really gets my goat. Let me give you a few examples of what some "experts" claim.

Now let me share something from the horses mouth, ie the makers of these charts. - - Read the text again. 

This is like the drivers who claim that their cars can fly, but the manufacturer of the car says you cant. Who do you trust? - I leave it up to you. 

However, I do think there is evidence for the use of Cumulative Delta Divergence, but again not without back-testing it. 

So to sum it up, I believe if you have backtested price data, that in anyway subsumes volume, if you want you could do correlated backtests along with volume data, even better, but you don't need anything more.

At the end of the day, you also need to understand that we humans cannot process so much of information that multitude of charts and indicators offer, we need to in a way simplify our decision making, by focusing on probabilistic models/frameworks fewer markets and instruments.

With that I rest my case on this. 

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.

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.

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 - 

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.

How to analyze markets on an Intraday basis? - Damon Pavlatos

I have been following Damon for quite some time now, he is a market veteran and has been in the broking business for decades now, he also happens to be married to another favorite trader of mine Linda Bradford Rashke.

In this short video he gives us a glimpse of how he looks at the market on an intraday level and that should tell us, the novices, what to do.