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1.understanding Value
1.understanding Value
By the same token, we cannot trade the spread if there are already
too many on the bid or offer - as is often the case in slower thicker
markets - and we use Effective Queue Position for making this
determination. From a value/edge perspective these crowded
conditions offer us nothing; in fact they take value and edge
away. So in this way Queue Position is our first input into
assessing value.
So for slower markets, we always begin with a scan of the bids and
offers to see if we can trade at the current price. If not, we wait
until the situation changes. Orders are routinely pulled and
traded against so this is a constantly changing environment.
Correlations
There is a big difference between price and value because value is a relative
concept.
You can neither determine value by just looking at its
price, nor by analysing its volume...
Let's say there is a small Ford family car that sells for $20,000. You know the price. Next
we reveal they sell 1,000 of these each month. Now you know the volume.
But if we ask you now, "Is this car good value?", you cannot provide an answer with only
the information we've provided.
But if we reveal that Toyota sells a very similar model for $20,000,
now you can judge whether the Ford is good value. You would
likely judge that the Ford is fair from a valuation perspective.
You can only determine the value of something
by comparing its price to something else.
Ironically, people naturally use "price comparison" whenever they
buy big-ticket items such as cars or houses - but when trade they
somehow forget this.
We use correlations to make judgments of relative value.
We must research our market and find which markets correlate well with it.
Both positive and inverse correlations are best if it is possible to get both.
That said, correlations are just one input, and are rarely near to 100%. We
do not trade in response to each uptick or downtick in correlation, but instead
use them as a guide as to which side of the spread to trade from.
Thus, correlations provide a key input into determining value vis-a-vis
comparison, but we are not suggesting you become a correlation
trader (their success rate is too unreliable alone).
Value can change even if
price does not.
Going back to our earlier example, let's say Toyota cut the price of their
car to $18,000 and the price of the similar Ford model stays the same.
If we now ask you if the Ford is good value, the answer has changed. The
Ford is now expensive, even though its price has not changed.
If we look at how markets work, we would expect fewer people to buy the
now more expensive Ford model, and eventually Ford will have to drop its
price. This is the mechanics of a market.
We get ahead of technical traders by assessing change in value before it is reflected in
their charts or indicators.
By watching markets trade by trade and using the above concept
of value, we know the moment when Ford is expensive relative to
Toyota. More importantly, we recognize a change in value before
it is reflected into the price of the Ford.
Technical traders won't see this because the shift in value will not
yet be reflected on their chart. Only when, over time, the volume
drops off and Ford cuts its price will they see that $20,000 was
expensive. Technical traders thus detect and react to a change in
value later than us. By the time they do, a Norden Method trader
has already executed with the aim of exiting their trade to these
slower reacting participants.
"We don't need to have edge over everyone in the market. We
just need to have edge over enough people" - Gary Norden
Given that most futures traders rely on technical tools and
continue to play an unreliable game based on "levels" and
"indicators", they will continue to be slower and less precise, and
thus continue to provide us an edge. And given the overwhelming
dominance of Technical Analysis (TA) in the education business,
we don't expect things to change.
Essentially we want to know whether our contract at
Point X is trading in sync with other markets trading
at Points Y and Z...
If the other markets say, drop sharply we may expect ours to as well. By doing this, we
understand context of the current price action.
We don't simply say that our contract is good value at 15. Instead we say that 15s are value
with other correlated markets at X and Y.
Anyone who uses support and resistance levels and any other form of
information that does not include context, will be making very simplistic
decisions. Understanding context helps us to make more robust decisions and
is one way that value traders are differentiated from price traders.
Each new uptick or downtick in a correlated market is
a potential new reference for value...
We watch our correlations tick by tick, trade by trade. Gary uses the
change on the day figure to watch correlations - others use DOMs)
For example, if a contract is +16 on the day and then prints +15, this is a
downtick and a potential signal for value to move lower (despite the
market being up on the day).
Price Acceptance
This part of the equation as far as value is concerned relates to the standard
economic definition of value; namely the value of a product is the price that
people are willing to pay for it.
We watch the market trade by trade and determine
where the heaviest volume is (for slower markets)...
For example, if the market is trading like:
15x 5 lots
16x 50 lots
15x 2 lots
16x 30 lots
By doing this, we are not buying or selling on hope; we know when we buy
there are others (of decent size) who are paying more and similarly when we
short we know there are decent size traders who are selling lower. Note that
for this purpose, we do not care what the 1 lot traders are doing; they do not
tell us value.
Recap
Note the number of pieces of information that we require in order to place an
order.
The Norden Method provides appreciable edge over
what is inherently provided by the spread.
IF the market is 15b/16o with bigger trades at 16
and Correlations suggesting a move higher - and the size of the bids and
offers suggest we can enter and exit quickly...
If you choose to trade with only some supporting evidence, we would term it
as an aggressive trade. If the trade fails you can leave that trade alone for the
rest of the day. However, sometimes traders back their instinct and we are
not totally against this as long as you respond accordingly if the trade fails.
Faster Markets
So far, we have looked at slower markets but how do we judge the current
value for faster markets which are jumping around?
Obviously we can’t use the same method of trying to work out where the
heavier volume is because of the jumping. So the method we use is quite
simple (it has to be due to the speed we are trading at).
In faster markets we simply use the last trading price
to judge current value.
So if a market trades 15 then jumps to 18, 18 is our new reference point for value.
We still use correlations too for that part of the value equation. And also remember that in
faster/thinner/more volatile markets we place orders further away from the last value
print.
It's very easy to overtrade fast markets believing
each new price print is new value.
It should be noted that this form of value analysis, while more
simplified than our primary method, will not be as reliable.
As with everything in the Norden Method, our method of Value Analysis is not to be used
in conjunction with any form of technical analysis or volume analysis indicator. Ideas
such as support and resistance levels, absorption, accumulation, and distribution are not
ideas used by market making professionals. We further explain why in the next module.