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Mind Over Markets: Power Trading with Market Generated Information

10.1002/9781118659724.app2, Downloaded from https://onlinelibrary.wiley.com/doi/10.1002/9781118659724.app2 by Cochrane France, Wiley Online Library on [11/12/2022]. See the Terms and Conditions (https://onlinelibrary.wiley.com/terms-and-conditions) on Wiley Online Library for rules of use; OA articles are governed by the applicable Creative Commons License
By James F. Dalton, Eric T. Jones and Robert B. Dalton
Copyright © 2013 by James F. Dalton, Eric T. Jones, and Robert B. Dalton

APPENDIX 2

TPO versus
Volume Profiles
H umans have a fascination with numbers. We crave exactness and abhor
ambiguity; if we can’t comfortably comprehend a piece of information,
we often discard it in favor of contrary indicators that match our precon-
ceived notions. Yet it is precisely in moments of uncertainty that the
experienced trader identifies opportunity, like the savvy angler who looks 335
for a subtle ripple in the slow water below a snag.
Consider volume, which can serve to validate market opportunities. You
must constantly ask yourself, “Is volume validating the current market
direction?” Volume profiles (not to be confused with Market Profiles) show
you exactly how much volume—including relative volume—occurred at
each price, as well as the exact number of contracts for the entire session.
See the example in Figure A2.1.
To reiterate, the three main components of the auction process are:
1. Price—advertises all opportunities.
2. Time—regulates all opportunities.
3. Volume—measures the success or failure of advertised opportunities.
It’s important to note that what the volume profile does not show is far
more important to the way I trade that what it actually displays. I believe it is
the more ambiguous combination of time and volume—rather than volume
alone—that provides the most timely, relevant insight (when considered
within the larger market context). Volume is important, but so is time,
because a price that is not accepted over time is, in fact, rejected.
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336
APPENDIX 2

F IGUR E A 2.1 Volume Example

All traders know the psychological pressure of time (tick, tick, tick). Being
in a trade that begins to stall can create serious psychological doubt. And the
longer a trade fails to advance in our favor, the longer we have to sit there
imagining what might be going wrong. For example, the late liquidation or
short-covering rally in the pit session may be the result of time running out for
day traders, rather than a lack of volume. The most likely scenario is that these
situations are caused by a combination of both factors.

S ing le P rice Level Distortions

It is not uncommon to witness much higher volume at or around a single
price level. For example, the previous day’s high or low, or the overnight
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high or low, is likely to attract above-average trade. Additional examples
include the opening and the halfback. When viewed on an absolute-volume
basis, these levels may appear to be far more important than they deserve to
be. Therefore, it’s imperative to view volume in relation to time, which is
more likely to smooth out these prominent levels, allowing us to better
maintain a more complete overall perspective.

End of Day Total V olum e versus Ong oing

V olum e throug hout the Day
Markets often develop a direction, or tone, for a single day. This direction
may not be confirmed by volume, however, even while the auction
continues until the close. In many instances, the movement is corrected
the following day due to lack of volume. In other words, there is often a
delay in the effect that such a low-volume move may have on a market.

A nom alies
An anomaly is a single price or price level that lacks symmetry, which
creates an unusual shape in the Market Profile. Anomalies represent 337
structural weakness, and they’re created through a combination of time

APPENDIX 2
and price—and therefore may not show up on volume profiles. In fact,
volume profiles alone often identify false anomalies, such as the previous
day’s high or low, as discussed earlier. These points of structural weakness
are often revisited during the current or following trading session.
The graphic in Figure A2.2 will help make this point.
It’s hard to believe that these two charts are from the same market on the
same day. The difference is revealed by combining volume and time. In a
conventionally constructed Market Profile, volume is estimated by multi-
plying price x time—the greater the number of TPOs reading from left to
right, the higher the estimated volume. While this method isn’t perfect, I
believe it offers superior insight to volume in a vacuum.
The Market Profile—with its extremely visual, pattern-forming TPOs—
enables me to better answer pivotal questions about how volume is being
distributed throughout the day:
Is volume being distributed within a rotational market?
Is volume being distributed as part of a trend?
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is underway. That way, I can compare the new volume to the old volume
I start a new Market Profile anytime I think that a new directional auction

within the context of distinct directional movements.

TPO Profiles Next to Volume Profiles
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Too F ocused on V olum e
Of course, volume is only one element to consider during any given trading
day. Among the other considerations (discussed elsewhere in this book, and
in Markets in Pro le) are:
Value—developing higher, lower, overlapping, and so on.
Which timeframe is in control (this is paramount).
Rotational trading day.
Trend day.
One-timeframing.
Short covering.
Long liquidation.

C onclusion
After a lifetime spent observing markets, I choose to give more emphasis to
the Market Profile—with its evolving, multidimensional structure— 339
because I believe it provides a more accurate representation of the auction

APPENDIX 2
process by juxtaposing volume and time. In addition, it smooths out aberra-
tions when there is high volume at the opening price, as well as other static
references, like the prior pit session high and low, and the overnight high
and low.
Ultimately, you must make your own decisions as you carefully choose
which tools you use and which indicators you follow as you trade. Rest
assured that no matter what you decide, there is never a single, simple
answer. I suggest you compare volume profiles and Market Profiles side by
side, writing down your observations as you see how they mirror and/or
contradict each other. What does the ambiguity tell you? Can you identify
change before your competitors (mostly laggards) transform opportunity
into the familiar patterns of consensus?