Market Profile – Weak Mechanical References
When we learn various ways of trading Price action, most often than not, we can see that most traders refer ; If the Price is trading above previous day’s high, its a bullish sign and if it is trading below the previous day’s low, its a bearish sign and if the market has taken support at the previous day’s high, its a bullish sign and if it got resisted at the previous day’s high, its a bearish sign and the same thing goes on for previous week’s high and previous week’s low.. so on and so forth. As we progress we see the market does not follow those levels to the tick and build a perception that a static or variable filter should be applied to save the stop losses at those levels or we should keep the buy order / sell order, a few ticks above / below previous week’s high / low so that if the market goes 1 or 2 ticks above / below the previous week’s high / low and falls / rises back then we would not get trapped. The reason these references are breached and tend to fail is that the day time frame traders tend to trade around these references. Those are either the ones who want to take few points and relax or the ones who are not aware of the opposite intermediate or long term forces that are present in the markets. In this post, Market Profile – Weak Mechanical References , I would like to show some recent examples n Nifty futures where the Weak Mechanical or the Visual references were at play and how the auction behaved around those levels.
Levels Marked on the chart are PDL – Previous Day’s Low PDH – Previous Day’s High PDC – Previous Day’s Close/Last Traded Price PDVWAP – Previous Day’s Volume Weighted Average Price
PWH – Previous Week’s High PWL – Previous Week’s Low
The Cyan colored dashed line represents Single Prints if any on the current day or from the previous days.
Yellow Lines that extend from previous Profiles are the Naked/Virgin TPO based POC – Point of control lines know as nPOC or vPOC marked with the date and the Lavender lines extending from previous Profiles are the Volume based naked POC known as VPOC or nVPOC .
The CHVN – Composite High Volume Node and the CLVN – Composite Low Volume Node also marked on the chart which are from the composites of the current or prior month depending on the range we are trading at.
The Vertical Brackets on the Left side represent the IB – Initial Balance in Green 150% Range Extension of IB in Dark Blue 200% Range Extension of IB in Blue & 300% Range Extension of IB in Violet
The Bracket to the Right of each Profile in Orange represents the TPO based Value area of that day and the Yellow line is the TPO based POC of that day. The bracket in Magenta represents the Volume based Value Area of that day and the dashed Lavender line represents the Volume based POC of that day.
Lets see what happened in the above chart as per the marked numbers :
- On 20-04-2016, the market opened above the previous day’s high and in the 1st half hour period A made a low just above the previous day’s high. The 2nd half hour period made a high above the A period high but pulled back within the A period range, which tells us that there is not enough momentum left to auction higher and in the 3rd half hour bracket C stayed within the A period range and again came down to the previous day high and finally in the 4th half hour bracket, the auction broke down into the range. What happened & why it happened so is the question. The simple observation is, previous day’s high is a weak mechanical reference that most of the traders would be watching to either go long by considering that as a support or may place SL orders around that level for their existing longs. The smart money or the OTF players do not care about these weak references that are visual and seen by the mass.
- What happened in E period is again a pull back low at yet another weak reference – previous week’s high. So do we expect this level to be broken again. Well, In Market Profile context, of course YES. We mark this level as weak reference but also look at the developing value and the longer term context. The context in F period was that F period again pulled back at a weak reference of the PDH so we have 2 opposite day time frame references at work now – The D period low and the F period high. The context of Value was that the value was not pushing down lower. Hence, we keep both the levels marked for future reference and wait for further development and exit any shorts that we would have created while anticipation the break of A period low.
- Almost similar to 20-04-2016, on 21st the auction opened above the previous day high and made a low just above the previous day high in the A period. The B period stayed within the A period range which becomes an inside bar pointing to the exhaustion in upward momentum again. The low of B period is near the A period low and the A period low is near the previous day’s high which becomes an even weaker reference. If we look at the context of Days then the auction is making higher highs on the Daily but when we apply these references then we have a carried forward reference from (2) and the fresh reference which gives us a short opportunity again. C period finally breaks down into the range leaving behind a single print, adding to the confirmation of shorts till the auction does not close that single print. J period tries to push back up but could not close the single print and finally the L period reaches the reference level that we carried forward from (2)
- On 22-04-2016, the market opened within the previous day’s range and the 1st half hour A period made a low just below the previous day’s low and the B period low is again at the previous day’s low. What happens next ?? Again we have a weak low as the reference is a weak mechanical reference that we mark and see how the auction develops further. C period broke above the A period high which is the Initial balance high, pointing towards momentum building on the upside. But remember, this momentum is not driven by OTF and may fade soon. We had a Trend day on 21-04-2016 and the nearest references we have is the VWAP of Trend Day, POC or the Fairest price of the day and the Value Area High of 20-04-2016 all very close to each other. The auction finally made a high at the previous day’s VWAP in G period with H and I period creating congestion and pointing to the loss in upward momentum. By now we know where the path of least resistance is – towards the weak low. K period pulled down towards the previous week’s high but could not push through the day’s low and L period again made a low near the K period low with M period gain pushing back towards developing POC.
- Now we have back to back weak lows as reference and need to carry them forwards either to be repaired during the day or with a gap. This does not mean that its a compulsion to break those references but this simply adds to our edge in taking the trades where odds are in our favor and the risk is least.
Hope the above explanation helps in determining the Market Profile – Weak Mechanical References and filtering the noise that usually surrounds around those levels. Many traders guessing why Nifty futures has become range bound is also due to these shorter time frame forces in play against each other and lack of longer time frame participation as the auction approaches a crucial longer term reference from where it started selling off in January 2016. In hindsight everything looks bright and shiny when freshers start trading Market Profile with the Value Area, but its not just about buy above or sell below the Value Area ; Market Profile is a vast subject and lot of nuances that need to be kept handy. Having said this, everything finally boils down to your own nature and time frame of trading and a daily profile by default is on 30 minute brackets.
To conclude this post, I would like to stress that do not change the way you trade just by understanding the weak references but do note them down, observe what happens in next few brackets and above all never forget the longer term context. There were many other references related to Value Area and Micro Balances in play as well in the above chart but I have pointed out the weaker references to let everyone understand one thing at a time.