The Rule If, after trading outside the Value Area, we then trade back into the Value Area (VA) and the market closes inside the VA in one of the 30 minute brackets then there is an 80% chance that the market will trade back to the other side of the VA. Using 1. Wait for the trade to close inside the VA. 2. Try and get best possible trade entry. If possible, enter from VA level that was crossed in order to close inside VA. 3. Target most of the position at the other side of the VA. Notes One trader noted to me that in testing the 80% rule using TradeStation the probability is actually 62% and not 80%. The trade supposedly gets its name from the probability of the outcome of the trade. i.e. There is an 80% probability that the market will trade to the other side of the VA. Look at your risk/reward when taking this trade. If the VA is only 2 points wide and you use a 3 point stop then this trade is probably not worth taking when the VA is this small.
Market Profile's 80% Rule
Tuesday, April 14, 2009
Where is the market likely to close? – Part 1
Wednesday, March 25, 2009
Calculating the close This article assumes a basic understanding of Market Profile and the terms used in Market Profile. No attempt is made here to explain those terms. Open Trade Close Market Profile The purpose of this study is to determine where the market is likely to close and trade given one of three Market Profile positional openings. The market can open above, in or below the Value Area. We want to know by the end of this study (1) where the market is likely to close (given its open) and (2) where the market is likely to trade (given its open). The types of questions that you will be able to answer at the end of this article and studying the tables in it are: This article does not attempt to suggest or give trading recommendations as no calculations have been done on Value Area size and/or distance the market may open from the Value Area. The data calculated for this article was calculated with the intention of producing tables of probabilities which will eventually lead to back tests being run using Market Profile to help develop strategies. Fair Data The first question I ask myself when back testing a strategy is: What was the back drop to the period in question when the strategy was run? If, for example, our strategy was to buy the open and sell the close and our back test showed this to be a fantastically profitable strategy I would be less impressed if I was then told that the period over which the test was run saw the market rise by 50%. I would also want to know how many days of data went into the back test. It's no different for creating statistical tables. You need sufficient data over a period which has seen a good cross section of market conditions.
Double Initial Balance
Tuesday, March 24, 2009
Calculating DIB in Market Profile Calculating Calculating Double Initial Balance (DIB) is easy: 1. Wait for the Initial Balance (IB) to form. This is usually the first hour of trading. 2. From this we get the IB High and Low: IBH and IBL. (The high and low during the first hour of trading.) 3. Calculate the IB Range (IBH - IBL) from these two figures. Let's call that IBR. 4. Add the IBR to the IBH and this gives us the Double Initial Balance High: DIBH 5. Subtract the IBR from the IBL and this gives us the Double Initial Balance Low: DIBL More Calculations Triple and Quadruple the IB can also be calculated. Add and subtract the IBR to and from the DIBH/DIBL to get the etc. to get the subsequent levels. Using DIB levels are used in Market Profile trading as support and resistance lines. We usually look for the market to turn at these lines which make them counter trend trades. DIB appears to be more effective when the IB is normal to large in size and not as good with small IBs. (This has not been quantified in tests but is the general belief in Market Profile.)
What is Market Profile?
Thursday, March 19, 2009
Market Profile is a graphical organization of price and time information. Market Profile displays price on the vertical axis and time on the horizontal axis. Letters are used to symbolize time brackets. Marketprofile is an analytical decision support tool for traders-not a trading system. Market Profile reveals pricing patterns from any market as they develop. By effectively organizing price and time information, it is possible for traders to see which price areas the market is accepting or which ones it is rejecting…and adjust their trading style accordingly. A price level that has been confirmed over time takes on added meaning. A price that is touched only briefly is just a price and little more. Confirmed by time, however, a price can reveal market value. J. Peter Steidlmayer developed Market Profile in the 1980s in conjunction with the Chicago Board of Trade. Traders who use it say that they get an in-depth understanding of the market, contributing to improved trading. Many factors can be monitored from Market Profile. Market Profile is not an indicator in the typical sense. It does not provide buy/sell recommendations but acts more like a decision-support tool. It organizes the data so that you can understand who is in control of the market, what is perceived as fair value, and the direction of the price move. It is possible to extract enough information from Market Profile for you to position your trades more advantageously. Market Profile is useful for the pit trader as well as the off-floor trader. The indicator can help the off-floor trader get a better sense of the market; prior to the introduction of Market Profile, only floor traders had access to this information. Although all references here refer to using futures contracts, Market Profile can be used just as effectively for other tradables. Software vendors such as CQG and WindoTrader provide Market Profile displays for equities. IN THEORY The concept of Market Profile stems from the idea that markets have a form of organization determined by time, price, and volume. Each day, the market will develop a range for the day and a value area, which represents an equilibrium point where there are an equal number of buyers and sellers. In this area, prices never stay stagnant. They are constantly diverging, and Market Profile records this activity for traders to interpret. Market Profile is based on the normal distribution curve, wherein approximately 70% of the values fall within one standard deviation of the average. If you rotate the normal distribution curve so that price is along the vertical axis and time on the horizontal axis (as shown in Figure above), you have the structure of Market Profile. A normal distribution curve assumes that the number of occurrences follow a bell-shaped curve. Anyone who has traded in the markets, however, knows that prices never follow a definite pattern; in fact, you rarely see a normal distribution. What you do see are skewed distribution of prices, which makes it possible to see the price at which most of the trades actually took place. This provides significant clues about the direction of prices and is the groundwork for understanding Market Profile. In theory, this helps the trader identify where prices are in relation to values. Monitoring price distribution over time gives insight into what levels are considered fair and unfair. You may take advantage of this information and identify good trading opportunities.
Gap Trading Strategies - Part 2
Tuesday, March 3, 2009
The Gap Trading Strategies
Each of the four gap types has a long and short trading signal, defining the eight gap trading strategies. The basic tenet of gap trading is to allow one hour after the market opens for the stock price to establish its range. A Modified Trading Method, to be discussed later, can be used with any of the eight primary strategies to trigger trades before the first hour, although it involves more risk. Once a position is entered, you calculate and set an 8% trailing stop to exit a long position, and a 4% trailing stop to exit a short position. A trailing stop is simply an exit threshold that follows the rising price or falling price in the case of short positions.
Long Example: You buy a stock at $100. You set the exit at no more than 8% below that, or $92. If the price rises to $120, you raise the stop to $110.375, which is approximately 8% below $120. The stop keeps rising as long as the stock price rises. In this manner, you follow the rise in stock price with either a real or mental stop that is executed when the price trend finally reverses.
Short Example: You short a stock at $100. You set the Buy-to-Cover at $104 so that a trend reversal of 4% would force you to exit the position. If the price drops to $90, you recalculate the stop at 4% above that number, or $93 to Buy-to-Cover.
The eight primary strategies are as follows:
If a stock's opening price is greater than yesterday's high, revisit the 1-minute chart after 10:30 am and set a long (buy) stop two ticks above the high achieved in the first hour oftrading. (Note: A 'tick' is defined as the bid/ask spread, usually 1/8 to 1/4 point, depending on the stock.)
If the stock gaps up, but there is insufficient buying pressure to sustain the rise, the stock price will level or drop below the opening gap price. Traders can set similar entry signals for short positions as follows:
If a stock's opening price is greater than yesterday's high, revisit the 1-minute chart after 10:30 am and set a short stop equal to two ticks below the low achieved in the first hour of trading.
Poor earnings, bad news, organizational changes and market influences can cause a stock's price to drop uncharacteristically. A full gap down occurs when the price is below not only the previous day's close, but the low of the day before as well. A stock whose price opens in a full gap down, then begins to climb immediately, is known as a "Dead Cat Bounce."
If a stock's opening price is less than yesterday's low, set a long stop equal to two ticks more than yesterday's low.
If a stock's opening price is less than yesterday's low, revisit the 1-minute chart after 10:30 am and set a short stop equal to two ticks below the low achieved in the first hour oftrading.
The difference between a Full and Partial Gap is risk and potential gain. In general, a stock gapping completely above the previous day's high has a significant change in the market's desire to own or sell it. Demand is large enough to force the market maker or floor specialist to make a major price change to accommodate the unfilled orders. Full gapping stocks generally trend farther in one direction than stocks which only partially gap. However, a smaller demand may just require the trading floor to only move price above or below the previous close in order to trigger buying or selling to fill on-hand orders. There is a generally a greater opportunity for gain over several days in full gapping stocks.
If there is not enough interest in selling or buying a stock after the initial orders are filled, the stock will return to its trading range quickly. Entering a trade for a partially gapping stock generally calls for either greater attention or closer trailing stops of 5-6%.
If a stock's opening price is greater than yesterday's close, but not greater than yesterday's high, the condition is considered a Partial Gap Up. The process for a long entry is the same for Full Gaps in that one revisits the 1-minute chart after 10:30 am and set a long (buy) stop two ticks above the high achieved in the first hour of trading.
The short trade process for a partial gap up is the same for Full Gaps in that one revisits the 1-minute chart after 10:30 am and sets a short stop two ticks below the low achieved in the first hour of trading.
If a stock's opening price is less than yesterday's close, revisit the 1 minute chart after 10:30 am and set a buy stop two ticks above the high achieved in the first hour of trading.
The short trade process for a partial gap down is the same for Full Gap Down in that one revisits the 1-minute chart after 10:30AM and sets a short stop two ticks below the low achieved in the first hour of trading.
If a stock's opening price is less than yesterday's close, set a short stop equal to two ticks less than the low achieved in the first hour of trading today.
If the volume requirement is not met, the safest way to play a partial gap is to wait until the price breaks the previous high (on a long trade) or low (on a short trade).
All eight of the Gap Trading Strategies can also be applied to end-of-day trading. Using StockCharts.com's Gap Scans, end-of-day traders can review those stocks with the best potential. Increases in volume for stocks gapping up or down is a strong indication of continued movement in the same direction of the gap. A gapping stock that crosses above resistance levels provides reliable entry signals. Similarly, a short position would be signaled by a stock whose gap down fails support levels.
The Modified Trading Method applies to all eight Full and Partial Gap scenarios above. The only difference is instead of waiting until the price breaks above the high (or below the low for a short); you enter the trade in the middle of the rebound. The other requirement for this method is that the stock should be trading on at least twice the average volume for the last five days. This method is only recommended for those individuals who are proficient with the eight strategies above, and have fast trade execution systems. Since heavy volumetrading can experience quick reversals, mental stops are usually used instead of hard stops.
If a stock's opening price is greater than yesterday's high, revisit the 1 minute chart after 10:30 am and set a long stop equal to the average of the open price and the high price achieved in the first hour of trading. This method recommends that the projected daily volume be double the 5-day average.
Modified Trading Method: Short
If a stock's opening price is less than yesterday's low, revisit the 1 minute chart after 10:30 am and set a long stop equal to the average of the open and low price achieved in the first hour of trading. This method recommends that the projected daily volume be double the 5-day average.
Gap Trading Strategies - Part 1
Wednesday, February 25, 2009
Today in the chat room a honourable member "asiatrader98" mentioned about gap trading. That is a new term for me and I've did some research on gap trading. I'd like to take this opportunity to share information I found and hopefully it can benefits other. Hope you like it. Gap trading is a simple and disciplined approach to buying and shorting stocks. Essentially one finds stocks that have a price gap from the previous close and watches the first hour of trading to identify the trading range. Rising above that range signals a buy, and falling below it signals a short. A gap is a change in price levels between the close and open of two consecutive days. Although most technical analysis manuals define the four types of gap patterns as Common, Breakaway, Continuation and Exhaustion, those labels are applied after the chart pattern is established. That is, the difference between any one type of gap from another is only distinguishable after the stock continues up or down in some fashion. Although those classifications are useful for a longer-term understanding of how a particular stock or sector reacts, they offer little guidance for trading. For trading purposes, we define four basic types of gaps as follows: A Full Gap Up occurs when the opening price is greater than yesterday's high price. In the chart below, the open price for June 2, indicated by the small tick mark to the left of the second bar in June (green arrow), is higher than the previous day's close, shown by the right-side tick mark on the June 1 bar. A Full Gap Down occurs when the opening price is less than yesterday's low. The chart below shows both a full gap up on August 18 (green arrow) and a fullgap down the next day (red arrow). The next chart depicts the partial gap up on June 1 (red arrow), and the full gap up on June 2 (green arrow). The red arrow on the chart, below, shows where the stock opened below the previous close, but not below the previous low. In order to successfully trade gapping stocks, one should use a disciplined set of entry and exit rules to signal trades and minimize risk. Additionally, gap trading strategies can be applied to weekly, end-of-day, or intraday gaps. It is important for longer-term investors to understand the mechanics of gaps, as the 'short' signals can be used as the exit signal to sell holdings.
A Partial Gap Up occurs when today's opening price is higher than yesterday's close, but not higher than yesterday's high.
A Partial Gap Down occurs when the opening price is below yesterday's close, but not below yesterday's low.
