chapter07 JWBK129-Dalton metrics January 4, 2007 15:19 Char Count= 0

Short-Term Trading 125

New expected
behavior
sell rallies

Prior trading
range low
130350
Day 8
130300

2-day
balance

Original
low
Early warning
late in downward
auction Upward
gap

FIGURE 7.11 Key reference points generated by the nonlinear break and coun-
tertrend rallies occurring in the S&P 500: Daily bar chart.
Source: Copyright ľ 2006 CQG, Inc. All rights reserved worldwide. www.cqg.com.

phenomenon is clearly manifest in the second countertrend auction, which

peeked up above the solid line into the previous balancing range, where it
quickly discovered that higher prices were cutting off activity and attract-
ing sellers; because the intermediate-term auction is down, in this instance,
this is the expected behavior. Of the three pieces of information that iden-
tified the ideal place for a short-term trade, two were tangible (gap and
prior trading range low) and the third, the expected behavior, was more
psychological.
Once the downward auction got underway, it continued for eight days.
Referring to the arrow marked “early warning” and the arrow pointing to
the original low, you will notice how price traded below the original low
and then traded back above that reference point for the next two days.
Earlier in in this book, we discussed the idea of “clean breaks,” which is
chapter07 JWBK129-Dalton metrics January 4, 2007 15:19 Char Count= 0

126 MARKETS IN PROFILE

applicable in this example. The point marked “original low” had managed
to contain price on the downside for 15 days after the market broke below
the upper trading range and upper gap. After this low was taken out, price
quickly returned to the 15-day range for a day and a half before resuming its
downside exploration. The “early warning” noted in Figure 7.11 is there be-
cause the break was not “clean”—in other words, once price broke through
the original low, it didn’t immediately continue downward. This provides
an early warning that the downside auction is starting to exhaust itself. As
you can observe, a few days later the market made a low and gapped higher
the following day, quickly returning to the previous 15-day trading range.
Before we review these same days via the market profile, let’s con-
sider the heightened emotional state that most traders and investors must
often endure. (If you’ve never traded, hopefully this will provide a glimpse
into the mental complexities that must be managed in order to trade suc-
cessfully; for those who have traded, this may simply add realism to the
discourse.) When you see a market analyzed after the fact, like we’ve just
done, it’s hard to understand just what it is that’s so difficult about trad-
ing. Performing this kind of analysis under stress is incredibly challenging,
and not just because money is on the line. For several years prior to the
nonlinear break we’ve been discussing, average volatility remained well
below its historic average, and individual trader and trading-system strate-
gies operated within a relatively low-volatility environment. Then came the
break and volatility rose rapidly. This kind of quick transition is hard to ad-
just to, both mentally and emotionally. During times of stress and sudden
transition, the mind has a tendency to become disoriented, often choos-
ing to focus on worst-case scenarios rather than the bigger picture. After
the break, of course the news shows rolled out the “bears,” continually fo-
cusing on the declining markets, how bad things were, and how bad they
could get.
Almost all of the experienced traders I talked to during this period
were similarly infected with the prevailing sentiment of doom and gloom.
No matter how well trained you are, no matter how experienced and confi-
dent and calm, it’s truly difficult to be objective when everyone around you
has lost their grip on objectivity, and price volatility is exhibiting nothing
but wide, volatile swings. When the market starts to whipsaw, it’s almost
impossible to catch your breath. Now the profile in Figure 7.12.
As shown in Figure 7.12, Day 8 was a trend day down, finishing with
a late price spike. During the next two days the market balanced from the
center of the Day 8 spike downward. This tells us that value was being
pulled lower to price, which is a good sign of downward auction contin-
uation. Day 10 also saw a late spike with price probing lower, once again
raising the question, will price be pulled back to value or will value migrate
chapter07 JWBK129-Dalton metrics January 4, 2007 15:19 Char Count= 0

Short-Term Trading 127

B
BCDE Last day we discussed
BCDEF in Figure 7.9 and the first
BCDFG
BCFGHIJ day down after the end
GHIJ off the second countertrend rally
IJK
JK Day 8 on bar chart
K
K
K
KL Price spike
KL
KL
KLM G
KLM FG
LM FGH Value overlapping to
LMN B FHI
MN B CDFHIJ
higher; however, still
MNP B CDEFHIJ in bottom of spike
NP BCD CDEFJKL from trend day
NP BCDH CDEFJKL
NP BCDHI BCDEJKLM
N BCDHIJNP BCKLM
BCDHIJNP BCKLM
BCDHIJLNP BCKLM Day 12
BCDEGHIJKLN BM BD
Day 8 CDEGHIJKLN BM Day 11 BCDF
DEFGHJKLMN BMN N BCDEF
EFGHJKLMN MN N BCDEFL
EFGHKLMN N N BCDEFL
EFGHLMN N BMN BDEFL
EFGMN N BMNP BDFGKLM Day 13
EFG NP BMNP BFGHKMN
F NP BCMNP BFGHKMN B
P BCMNP FGHJKMN B
Day 9 BCLMNP HIJKN B
Day 10 BCLM IJN B
MCELM IJNP CDF
MCELM IJP CDFG
BCDEKLM IP CDEFGHI
BCDEKLM CDEFGHIJ
Value develops at DEJKL CEFGHIJK
DEJK CEFJK
bottom of price spike, EJK EK
value pulled down to EHJK EK
EGHJK KL
price EGHIJ KLM
EFGHIJ LM
EFGHIJ LM
EFGHI M
EFGHI MN
FGI MN
FG MN
F N
F NP
F NP
F P

FIGURE 7.12 Further analysis of the nonlinear break and countertrend rallies
occurring in the S&P 500: Multiple daily profiles.
Note: The market profiles in this figure have been condensed to fit the page, which changes
the scale and can result in slightly misleading profile shapes.
Source: Copyright ľ 2006 CQG, Inc. All rights reserved worldwide. www.cqg.com.
chapter07 JWBK129-Dalton metrics January 4, 2007 15:19 Char Count= 0

128 MARKETS IN PROFILE

to confirm the lower price probe. As always, we focus on value, not price.
On Day 11, a value trader saw clearly lower value, while a price trader saw
unchanged price. Day 12 exhibited overlapping-to-higher value and lower
price. Day 12 was also a balancing day, which positions us for a new direc-
tional trade once the market leaves that balance range.
However, there is clearly conflicting information due to the fact that
Day 12 resulted in overlapping-to-higher value, while both Days 11 and 12
remained below the average balance of Days 9 and 10, which alerts us to
the fact that the intermediate-term auction down may be tiring—but isn’t
necessarily over. This lets us know that the risk of remaining short has
grown substantially; successful trading/investing is based on identifying
advantageous probability.
Day 13 was another trend day down with a late downward spike. Fol-
lowing this activity, we again observed to see if value was pulled lower
on Day 14, which is exactly what happened. In Figure 7.13, notice the ar-
row labeled “early warning” in the upper portion of the Day 13 profile. The
nonelongated profile shape provided another alert that the auction was tir-
ing. During this day, the news reports were growing more pessimistic as
price continued lower, and those with short positions were probably feel-
ing more and more comfortable.
Day 14 provided clearly lower price and value; however, notice another
“early warning” arrow—the fat shape of the profile suggests that lower
prices are not engendering continuation to the down side. Our evidence
shows that while prices are steadily migrating downward, the market is
struggling to move lower, laboring step by step without the freewheeling
conviction that accompanies sustainable directional movement. But think
about how this feels in the moment. When you look only at price, the mar-
ket is clearly moving lower. How in the world could you buy? This is an
opportune place to reintroduce Gladwell’s diffusion model. At this stage
in the auction, it is the late majority and the laggards who are dragging
price downward because they focus only on price and because they’re
scared—what if I’m missing out on the next major trend?
On this day, if you could have measured the collective emotions of
all market participants, you would have found a predominance of fear in
those who were long, and a great deal of confidence in those who were
short. But if you considered the balance of market-generated information
that we’ve been discussing, you’d have found evidence that just the op-
posite was true. During this frenzy of market volatility, if you were able
to acknowledge your emotions as a product of herd mentality and news
hype, instead focusing your empirical mind on the patterns being revealed
in market structure—revealed by organizing purely market-generated in-
formation via the market profile—you would have seen that the market
was struggling mightily on the downside.
chapter07 JWBK129-Dalton metrics January 4, 2007 15:19 Char Count= 0

Short-Term Trading 129

N BCDEFL N
N BCDEFL N
BN BDEFL N
BMNP BDEFGHKLMN NP
BMNP BFGHKLMN NP
BMNP BFGHKMN NP
BCMNP BFGHJKMN B Day 13 NP
BCMNP FGHJKMN B N
BCMNP FHJKMN BC MN
BCLMN HIJKN BC MN
BCLM HIJN BCD Early warning LMN
BCELM IJN CDFG LM
BCELM IJNP CDFG LM
BCDELM IJP CDFGHI LM
BCDEKLM IP CDEFGHI LM
CDEJKLM CDEFGHIJ L
DEJKLM CDEFGHIJK KL
DEJKL CEFHIJK KL
DEJKL CEFHJK KL
EJK EJK K
EHJK EK K
EHJ KL K
EGHJ KL Day 14 K
EGHIJ KLM B DEJK
EFGHIJ LM B DEFHJ
EFGHIJ LM B DEFGHJ
EFGHI M B DEFGHIJ
EFGHI M BF DFGIJ
EFGHI M BCFG CDIJ
FGI MN BCFG Early warning CDJ
FG MN BCFG BCDJ
F N BCFG BC Gap
F N BCFGH BC
F NP BCDFGH BC
F NP BCDEFGH B
F P BCDEFGHIJ B
P BCDEFGHIJK B
BCDEHIJKN B
BCDEIJKMN Day 15
BCDEIJKMN Day 16
DEIJKMN C
DEIJKLMN C
DEIJKLMN BCNP
EJKLMN BCDNP
JKLMN BCDNP
KLMN BCDEFGNP
LMN BCDEFGKN
LMN BCDEFGHIKN Balanced day
LMN BDEFGHIKN
LMN BDEFGIKN
LMN BDEFGIKLN
MN BEIKLMN
MNP BEIJKLMN
MNP BIJKLM
MP IJKLM
P IJLM
IJL
JL
JL
L

FIGURE 7.13 Further analysis of the nonlinear break and countertrend rallies
occurring in the S&P 500: Multiple daily profiles.
Source: Copyright ľ 2006 CQG, Inc. All rights reserved worldwide. www.cqg.com.

NEVER BE A LAGGARD

We have spent a good deal of time discussing the notion of timeframes

and conflicting information. Trading is extremely difficult when you aren’t