James Dalton on Market Profile – Traders Carnival 2016
It was a week well spent at Holiday Inn – Bangkok from 14th May to 21st May during the 5th edition of Traders’ Carnival 2016, more importantly for me as it was my 1st one on one meeting with James Dalton and on top is was an opportunity that I may not get again, to speak on the basics of Market Profile, sharing the same stage from where James Dalton explained Market Profile with such simple examples that even a person who has not heard about Market Profile earlier would understand it and those who already know about Market Profile will be able to clear their doubts. In this post I intend to note down few important points that he made during the two sessions where he spoke not just about Market Profile but also about his approach to trading as well as the Mindset of a Trader. Few points here are from my one on one talks with him, though I will not be able to pen it down completely as it would not be fair to the participants of #TC2016 who came all the way to Bangkok by paying the tickets for the session so few things will obviously be limited to those who attended #TC2016
A brief info about James Franklin Dalton
James Franklin Dalton aka James Dalton aka Jim Dalton aka Jim as all fondly call him has been a member of Chicago Board of Trade as well as a member of Chicago Board Options Exchange and Senior Vice President of the Chicago Board Options Exchange during its formative years. Jim was also part of forming and floating $SPY – SPDR S&P 500 ETF. Coming to Market Profile, Jim’s discount brokerage firm J. F. Dalton Associates had sponsored J. Peter Steidlmayer & Kevin Koy’s book Markets and Market Logic in 1986.
He has authored Mind Over Markets and Markets in Profile which sums up his notes on the two way auction process and the power of trading the market generated information. Pete along with Hawkins wrote another book where he covered the Market Profile in depth but later moved away from trading based on Market Profile as he thought that what used to work in Pits does not work in Electronic trading. As the market evolves, we also need to evolve & Jim picked up the useful nuances and carried on the legacy of Profiling till he retired from James Dalton trading recently, his firm where he used to advise hedge funds & impart education on Market Profile. He has over 43 years of experience trading the markets and though he retired from the full time business, he still trades for a living even when he was in Bangkok & showed us his trades which he generally does not do even to his clients as he believes to teach how to catch the fish rather then feeding a fish.
Not a Market Profile Trader
Jim says that he is not a Market Profile trader. He is a discretionary trader and uses the Market Profile to organize the Data. Our mind can process a graphic better than any other information and as per a research it takes 13 milliseconds on an average to get influenced by a graphic presentation.
Top Down Approach
Jim prefers a top down approach while analyzing the markets. Start from a Monthly chart then a Weekly chart then a Daily chart and then dig down further to a Market Profile Daily chart to understand the structure and to estimate which time frame players are in control. If monthly is trending up/down, weekly is in balance and daily is in balance then its more likely that when we get a break of a day time frame level, either the trend will reverse or continue on the side of monthly and same with weekly breakout or breakdown. When all are trending then best not to try to fade any moves.
Day time frame or the shorter time frame players are constantly looking out for compulsive trades at the daily/weekly/monthly highs or lows or closes and its not too late that they get extremely long or short when they loose the capacity to move the markets in their favor. As there is no long term money coming in, the market gets saturated on that particular side and tends to give opposite reaction. With the help of Market Profile we can spot out this behavior and use it to our advantage.
Failed auction of the Initial Balance high and low as a concept is not part of Jim’s study on Market Profile and Ray Barros had done a research on the same and stated that a 1 tick failure break of IB in a particular bracket and a range extension on the other side has a chance of that level being revisited within 5 days and if it fails to revisit that price then it hints to a start of a new IPM which Pete referred as a process in his book. The FA research was done many years back and markets are changing constantly and moreover the research was on $ES_F and Jim cleared my doubt that he does not look at failed auctions as it is like looking for just one level whereas markets are random and we might miss a bigger opportunity while looking at the exactness of the levels or rules. Auction failures can happen anywhere at any level and on any time frame. So important usage is to understand our own time frame that we want to trade and look for Auction failures in that time frame. A push above value and back into value is an Auction Failure, a push above a DTF reference and back is also and auction failure and many such failures keep happening constantly & we can react after assessing the risk involved.
The 80% rule
It was Jim’s observation years back that when the market opens below/above Value Area and enters the value area and trades within the Value area for 2 consecutive brackets then there is 80% chance that it will travel to the other side of the Value area. Over the years the markets have changed and the 80% rule is not working consistently any more. Its better to use what works than to stick to rules and levels which we cannot force upon the markets.
Weekly and Monthly Profile
Jim does not look at Weekly or Monthly profiles as market are not linear and they can be doing something else on a bigger time frame and Market Profile was made primarily to look for the daily two way auction process so Jim looks at the bar chart of weekly and Monthly to see if the markets are trending or balancing & over the years he can make out the value on those time frames where there is a balance but does not use the Value area on those time frames for trading levels.
Composite & Micro Composite Profile
Jim used the Micro Composites and the Composites of few hours to days to months to see where is the market balancing as the purpose of the auction is to travel from balance to imbalance and back to balance. The word Balance needs to be treated as important while making composites as if there are 2 or 3 distributions within a particular period then all are separate balances and each of them have a value. Having explained that Jim does not use the composites any more as he can just visualize them on bar charts as those references come into play once the precise structure of Day Profile is doing something crazy around those levels.
Poor and Weak Highs & Lows
In a two way auction process the market participants of a short time frame or day time frame tend to play to the exactness of levels and in that process tend to break the day/week/month high or low by few ticks and come back to the same levels in the next bracket or even on the next day or next week. Such levels that are almost equal to one another are weak highs or lows and have a fair chance to be taken out. Poor highs and lows are similar but not necessary to be around visual references. If a market is falling in one bracket and we do not have a decent tail and the next bracket make a low just near the previous bracket low then its a poor low and has a fair chance of being taken out.
Excess marks the end of one auction and beginning of another auction. This is important to remove the exactness of the Failed auction concept as excess can happen even after 2 or 3 brackets trading above IB. The market does a range extension above a swing high and fails to stay there and comes back in range is an Excess and gives a clue that the Other Time Frame participants have no interest to let the market go up. Similarly the Excess in this case becomes a selling tail as well as a auction failure above swing high. And yes no rules for the excess to be revisited.
Value Area as a Trading Level
Markets hate precision. The people who are obsessed playing to the exactness of the Value Area Low or Value Area High or the Point of Control are no better than those playing at the OHLC levels & there is a fair chance that they enter into emotional trades and the other players are waiting for these players to jump in so that they can be wiped out.
Trade entries & Exits
Entries and exits from a trade are discretionary and can be done with the help of various methods. Once we understand the context of what the market is trying to do, it becomes easier to take an informed trading decision. A market trading below the previous days’s close gets too short and there are fair chances that a late afternoon rally can take place so in that case we look for an inside bar which can point to the market doing nothing much on the downside and enter a speculative long. Speculative longs or shorts whichever i take initially are with Options as they give me enough freedom to later build on the positions if the trade goes right. We enter when the odds are in favor and there is no thumb rule that the market has to reach a particular reference if its too long or short but still from experience you can observe the behaviour of the instrument you trade and can mark a probable destination point. A trend trader can trade sideways market as good as a trending market with Market Profile as he knows that its time to fade the moves
Market overall does not care about our conviction. If we are long with conviction does not guarantee at all that the market has to go up. Conviction in a trade is similar to the intuition that you develop trading an instrument for a long period of time. but when we talk of conviction of different time frame players then the Open can give a good clue about the directional conviction. An open out of range is a conviction that the market still has strength left to extend the trading range whereas an open within range has lesser conviction that the range can be extended and its likely that the market rotates within a narrow range till it can find a force to drive it in one direction.
Stop losses are the last resort to save your capital and protect you from going bankrupt. Last means there are many other ways as well. I must have hit only 5% of my stop loss. Why to wait for the stop loss to hit when we can assess from the Market Profile that some other participants are trying to take the market against the position we are in and its better to exit that trade before it even hits Stop loss as chances are that it might eventually hit our Stop loss.
Well everyone knows that long liquidation or short build up or long build up or short covering happens all the time in a market place. If you ask me who drives the Short covering then A bill a John and a Terry drive the short covering rally. In other words we do not know the names of people driving the rally but from the Profile we can assess what time frame players they are and what will be their likely behavior.
TPO Profile v/s Volume Profile
I always use TPO profile as the primary idea of Market Profile is to use time as a constant and price as a variable. When we look at the Market Profile Graphic we can estimate what the price is doing and where is it creating a value and what is the accepted fairest price of that range. The logic here is that
- PRICE ADVERTISES OPPORTUNITY
- TIME REGULATES THE OPPORTUNITY
- VOLUME REGULATES THE SUCCESS OR FAILURE OF THE ADVERTISED OPPORTUNITIES
So we do look at the volume created at the time of balance breaks or any reference levels breaks but using a Volume Profile will loose the importance of the above concept. There are many who use Volume Profile in place of TPO Profile but that is not what i would like to do.
Markets most of the time never do what you want them to do and when you want them to do. It never happens when you want it to happen. Just because you are paying for the equipment and data does not mean that you have to be in the trade all the time. Let the trade come to you. Listen to the markets. If you talk to the markets you are missing a big opportunity as the market does not listen 😉
Larger the gaps, lower the odds of the Gap getting filled on the same day or in a short run. They are created by long term players and they keep driving the markets in their favour till they have their strength. The worse thing you would want to do is to oppose the long term players. They have some serious money.
Algos are there and they are the ones who provide liquidity. Why would anyone be scared of liquidity. Few people tried to code algos based on Market Profile levels and they failed as Market Profile is dynamic approach and not a rule based approach that can be coded efficiently.
Economic Data Announcement
Its important to know the date and time of the important Economic data releases but the numbers and their impact are not so important as the market participants, mostly Day time frame and short term traders react to such economic data releases and that is visible on charts so we are better off trading whats there on the charts.
At the end of the event I presented Jim with a memento of his portrait made up of Market Profile letters. Could not think of a better gift to the legend.
The number one thing that kills traders is Cognitive Dissonance. You don’t want to believe the market – Jim Dalton
Do not try to teach the market a lesson – Jim Dalton
And last but not the least, Jim’s take on the US markets in an excusive interview with CNBC – TV18 came as a surprise as Jim generally does not do interviews.
I am still trying to internalize the precious information shared by him and making efforts to use it to the best of my benefit.
Really a Nice and to the Point Write up. This gave in short but almost bursted many myths about MP and Trading.
Awesome work. Expect some more writeup coming.
ThanQ for a gem.