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The Market Profile Approach to Trading


One of the problems with the conventional charting method, the open-high-low-close bar chart, is that it does not visually portray where most of the trade is taking place.


Market Profile Introduction

Like many traders when they first begin in this business I wanted to understand everything! My initial focus was studying the fundamental aspect of commodity markets, but after computerization made charting easier my attention turned to understanding the technical picture and the different indicators. All of this was valuable, but I never found a technical approach that made sense to me until I was introduced to Market Profile. What makes this different from bar charts and candlestick charting is the way data is organized.

Back in the 1980's a bright trader at the Chicago Board of Trade began to observe markets through a different lens. I first saw Peter Steidlmayer trade in the soybean pit and marveled at how often he was on the right side of the market. Many times he would fade the locals and his entry/exit levels were spot on. As luck would have it he began to teach some of us his method and in conjunction with the CBOT he developed a method of data entry that in real time shows a two-dimensional visual picture of the market which he called, Market Profile.

One of the problems with the conventional charting method, the open-high-low-close bar chart, is that it does not visually portray where most of the trade is taking place. Bar charts are linear as they show an inflexible horizontal axis with no variance. In other words during a given day each time slot goes forward without reflecting the extent of market activity that occurred in a particular time period. This is what Steidlmayer set out to change by introducing more complete data that shows the vertical price bar alongside a horizontal volume bar.

Click to see larger image

This enables a trader to see both time and price in action and patterns begin to form which, once understood, creates opportunities throughout the day for the day-trader. This also works equally well for the swing trader or long-term trader as the software allows you to merge daily profiles to create a bigger picture.

The Market Profile is not a trading system but rather a structure that uses the components of time, price and volume which are then combined and displayed in a horizontal and vertical distribution much like a statistical bell-shaped curve to reveal pricing patterns and value. Through study and observation one can learn to identify the market's underlying dynamics and structure and trade accordingly.

Market Profile is "user friendly" for many reasons:

1) There are a finite number of daily patterns to understand that continuously repeat.

2) Identifying patterns early alerts you to what type of trading day is developing. Knowing early in the day if we are going to have a trend day or a trading range day is highly beneficial to the daytrader.

3) During a given day there are basically four steps that repeat themselves over and over again and by understanding this "blueprint" of market activity you have a higher chance of anticipating the next logical step in the market's development. You do not need to memorize hundreds of potential set-ups.

4) A trader can also quantify the potential move.

5) This approach allows you to watch the "point of control," develop the area of highest market activity and as a result you can see in real time if the market is accepting or rejecting the area.

6) You do not need a comprehensive understanding of how markets work under all conditions. A general understanding of markets and patterns are enough to create trading consistency and profits.

Trading is a process of self-discovery, trust and consistency. Tools and studies that help to identify recurring patterns and keep you objective are needed to compete at a high level in this game. Whether you are day trading or choose a longer time frame, Market Profile generated data helps to identify market patterns, good trade location and identifiable risk management levels.

As a trader I believe in using what works and applying Market Profile with more traditional indicators to confirm trades. The key is to always realize that these are all tools and as I like to say they are handrails, not holy grails and are to be used with discretion. Nothing works 100% of the time, but our job as traders is to find our niche that helps us create trust and consistency. If we have that, the profits follow and then the challenge is to keep our ego at bay and continue to follow the rules.

In the future I will review trades in different markets to show the distinctions of Market Profile data.

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No positions in stocks mentioned.

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