Frank

I was re-reading some of my earlier posts and wanted to explore one concept presented in context of some recent/current auctions. For now, let's just look at the gaps and ‘value migration’. The market is a series of 2-way auctions where value migrates one way for a period of time and then auctions the other way. So ‘value migration’ and auctions are essentially one in the same. You are gauging the intraday order-flow within the context of the order-flow occuring at a higher level. The gaps (and tails) signal 'excess' has occured and 'excess' is what marks the end of one auction and the beginning of another. Of crucial importance is where the gap occurs. In this chart, I have tried to represent order-flow in terms of action relative to a higher timeframe value migration. Value migrates one way during one auction and then migrates the opposite direction. But value beginning to migrate up during a large value migration down is different than value migrating up after a good auction reversal. Separating these two similar situations is of crucial importance. This indicator is based on what is happening with current order flow in context of a moving average, which will be a proxy for higher timeframe value migration. 'Current Value' is being defined as the average of intraday VWAP and the close of each 30-min bar. This will smooth out the calculation of ‘current value’. The moving average is a 40-period simple moving average of just the closes of the 30-min bars and therefore is representative of the last few days average value. Note how an auction changes directions, accelerates, then deccelerates and the moving average 'catches up' to current day 'value'. This signals that the auction is aging --- but not necessarily over. A gap or a tail will usually occur to signal the end of one auction and the beginning of another. note: the current auction trend is still up. why? because Fridays 'value placement' is still well above recent days of value (as seen in the moving average). the market did not elongate to the upside on Friday but the overall structure is still generally constructive. a move lower on monday could be thought of as potential opportunity to buy in a constructive larger auction at a price below recent value.

<<how do you know E period is an excess ?>> good question. you will never really know if sellers (buyers) will show up or not in advance. market profile is really more about understanding some core trading concepts and securing good location for your entries. In this case, following a day of strong trending action -- the market has very high odds of exceeding the high of that day on the following day. 'Inside days' are actually pretty rare (~12%). Thus, you should not be shorting BEFORE the market exceeds the previous day high. But shorting AFTER the penetration of the high and in periods A-E is now a decent idea to consider. Here is another concept unrelated to Daltons teachings but a helpful guideline. Once the market picks a direction for the day, it will often continue to go that direction for multiple HOURS. Many times (>50%), the market won't make its FINAL high or low until the final hour of the day. It will just chug and chug and chug directionally for hours --- away from the high or low it made in the morning. Thus, if it does make a high in B-E, you will be sitting on a good position that you can ride for hours. There are many other concepts that can help gauge the odds. Oscillator divergences, Moving Average regression tendencies on certain days of the week, confirmation from other indices (Dow/Nasdaq/Bond Market etc...). I will try to get some more of these important chapters (6 & 7) done soon.

Let's looks at a recent 'Excess High' to demonstrate some of these concepts. This is from March 12th: March 11th was strong up day as seen in the hard afternoon buying which created an elongated profile. March 12th opened right on the previous days high. After a quick test down periods B & C (the first hour), buying came back in and pushed price materially above the previous day high. Why would you consider shorting here? Because: 1) You know that the first ~2 hours of the day are known to often show reversals (periods B-E). 2) Price trades above previous day high, creating the potential for a daily 'selling tail' to form. You do not KNOW at this point sellers will come in. But you know that this isn't a 'innvoator' or 'early majority' level for sure. This is 'asymmetric location' to short. If you are right, you will catch an auction down. If you are wrong, then risk is controlled. On this day, laggards of the last auction met innovators of a new auction in period E. Period E is the 'Excess High'. (it turns out that price pushed up into a resistance zone at 1336.50 and this was a natural 'reversal zone' to look for).

(Chapter 6 and Chapter 7: Intermediate and Short-Term Auctions/Trading) Part 1. Rather than keep this to just intermediate term auctions, lets use the extremely important concepts of this chapter and relate it to all timeframes. I cannot overstate how good this stuff is – thanks to Jim Dalton & Co for writing this book. Let’s review again these statements: “Recognizing where you are in the auction process determines your risk/reward relationship.” “The end of an auction offers the moment of greatest opportunity… risk & return are asymmetric at this point.” “Auctions complete when the laggards from the last auction are met by the innovators from the new auction.” Ok, this is Market Profile at its core. Through all timeframes (intraday or longer-term) – you need to understand how an auction ends. By understanding the signs of how an auction ENDS, you will know not only whether to enter a new order --- but also whether to stay with the flow of the current auction (either through holding on or re-entering on a pullback). Later we can discuss how a bracket ends and a new trend begins. For now, lets focus on the former --- when one auction ends. The market is a series of 2-way auctions. The end of one auction leads to a new auction in the other direction. If you can figure this transition out, you are entering an order with big reward as you are in on the ground floor of a new auction. When you get it wrong, you will know quickly because of how you are ‘marking’ the end of the auction. Let’s get to it. What is it that marks the end of an auction? (perhaps the most important concept in the book, imo). “‘Excess’ marks the end of one auction and the beginning of another” ‘Excess’ can be seen in 2 primary ways: 1) A key Buying or Selling Tail 2) A key Gap Excess occurs when a market makes a dramatic price high or low on low/moderate volume and opposing buyers or sellers react quickly and aggressively by auctioning price in the opposite direction. Sometimes this is in the form of a tail (a strong volume-based rejection) and other times in the form of an overnight gap (a gap that catches a market that got too long or short into the previous days close and has now ‘trapped’ those traders). Be on the lookout for these two key signs of excess: the tail and the gap. This is so important in understanding the entire auction structure, IMO. If the recent auction is downward and an auction low has been established with a buying tail, the investor who correctly recognizes the low and buys has a low risk/high reward (asymmetric) position. Why? His risk is that the 1-bar tail gives way (or less risk if you can fine-tune entries and re-enter if necessary). The reward for being right is an entire auction in the opposite direction. In a pure sense, the absolute ideal location for entry is precisely on the price bar where an ‘excess low’ or an ‘excess high’ forms. This is the price bar where laggard meets innovator and this is where you would ideally like to be. This is not just from Daltons chapter now, this is my own experience inspired from this (excellent) Dalton chapter. Much of the time, the key ‘innovator-laggard intersection bar’ will be in the first 2 hours of the trading day. The most often will be the opening 30-minutes of the day, especially if the market has reversed down (from up auction to down auction). In general though, be on the lookout for a key buying or selling tail in the opening 2 hours – with particular emphasis on the first 1-2 30-min bars. Regarding the opening 30-minute bar, I should also point out that any strong movement off the opening price can be considered similar to a ‘tail’ in and of itself. Range Expansion off opening price is an important concept. Though not really a big part of Daltons book, think about this as you study 30-min bar charts of morning reversals. Another thing is that a tail in the morning session is best if it has also exceeded the previous days high or low. That is, a good buying tail will rinse below the previous days low and create something of a double tail --- a 30-min tail AND a tail on the daily chart. Likewise, a good selling tail should go above the previous day high and get ‘rejected’ by higher timeframe sellers --- and most of the time this will occur early in the session. The previous days high and low are very important ‘reference points’ in market profile. The second form of ‘excess’ after the violation/tail is that of a gap. : “A gap at the end of an auction that occurs in the direction opposite the most recent trend signals a reorganization of beliefs. Market participants have changed their perception of value so dramatically that they simply begin trading at a completely different price level.” 2 things with gaps. 1) Gaps represent ‘overnight inventory’ --- traders who have entered positions overnight will generally be ‘weak-handed’. If price does not move in their favor quickly, they will panic out. This is part of the reason the first 30-min bar marks the high or low of the day more than any other single price bar. 2) Gaps are a bit tricky to enter on. You will need to understand the bigger auction structure or else a key auction-reversal gap will leave you in the dust. A good deal of the time, the market will gap and auction in the direction opposite the gap. Thus, you cannot just chase gaps and label them all ‘auction reversal’. You should just be aware of the key auction reversal gap if the structure of the recent auction also suggests it is losing momentum or is otherwise long in the tooth. Remember, you will not be looking for tails or gaps in isolation. You will have a lot of context from your other indicators. Essentially, you will be watching the auction accelerate and then mature and then look for your tail/gap reversal signal. Market profile consists of many things that you have to synthesize into a composite answer. What did the histogram look like over the last ~3-4 days? Has the market been soaked of its buying/selling pressure and now poised to reverse? Or is buying/selling pressure still strong? Was volume getting stronger or is it getting weaker? Is the last auction long in the tooth? How did the market close yesterday relative to what it was ‘trying’ to do? In the context of the overnight move with the other indicators, what is the likely state of inventories across timeframes? When you put together these concepts, you get a good idea of where you are in the auction. When you combine it with the tail/gap indicator --- you are now ready to enter an order as you will have located your asymmetric location (the ‘innovators entry’). Even if you miss your ‘ideal’ entry, you still could get something similar to a ‘early adopter’ entry (1 step removed from innovator but still good location in the context of a bigger auction). So long as you understand the structure of the auction and are making entries and exits within that framework --- you will be entering orders with the flow of the current auction. I realize at this point that I am basically writing a rough draft of something that is no longer a pure book review. Oh well, will just wing it for a while. Eventually, this will get back to the original structure.

Chapter 5: Long-Term Auctions This chapter is in some ways the lightest content chapter in the book, in my opinion. Nevertheless, there are a few good (inter-related) concepts in this chapter: 1) The market price only has to be ‘fair’ in the day timeframe. 2) On longer timeframes, markets do not go directly from Bull Market to Bear Market or from Bear Market to Bull Market. They enter intermediate term ‘Brackets’ in between bull and bear markets. 3) Longer-term players may disregard short-term balances that spawn short-term auctions. However, traders and investors of all timeframes should pay careful attention to higher timeframe breakouts as they include participants from all timeframes and can therefore bring large momentum moves Long-term charts (auctions) are for context. You don’t act on indicators or patterns based off of long-term charts in reality but they give you an idea as to remaining cognizant of what can happen if and when all timeframes align at key points in time. This is not from the book but is a good analogy I got from another trading book that fits here. This is like being at the ocean and the waves are going in and out. Imagine you are watching that little whitewash current that sucks the water in and out before a wave comes in. Well, sometimes that little current is running in and out and you think you understand the rhythm. But then occasionally that little current gets sucked out and it runs straight into a monster wave that shoots further up the beach than a wave has all-day. THAT is what can happen if you are not cognizant of what is going on with the long-term charts. Major market ‘breaks’ are non-linear, they auction VERY quickly once underway. These will not happen very often if you are focused on short-term trading – but when they do – they will be extremely powerful. A Bull market does not convert instantly to a bear market. An intermediate term ‘bracket’ forms first. The next chapter (chapter 6) is about intermediate-term brackets. Thus, this chapter is really about understanding whether you are in an intermediate-term bracket or in a major bull or bear trend. An intermediate term bracket will feel violent at times. A Long-Term non-linear break will feel stronger than that… To me, the bigger issue here is watching the daily timeframe in context of the intermediate term trend or bracket (the next two chapters). There isn’t that much more in Chapter 5 regarding long-term auctions except to say --- expect extreme non-linear movement to occur from time to time and be ready for it. The next two chapters: Chapter 6 (Intermediate-Term Auctions) and Chapter 7 (Short-Term Trading) are probably the 2 best chapters in the book.

Will be continuing shortly... Reminder of the key 'Innovator-Laggard' Framework from Chapter 1:

This such a true statement I have to include it in this thread: "Beginning poker players [traders] sometimes ask, “What do you do in this particular situation?” There is really no correct answer to that question because it is the wrong question… The right question is: “What do you consider in this particular situation before determining what to do?” – David Sklansky, ‘The Theory of Poker’

Chapter 4: Auctions and Indicators Up to this point, Dalton has discussed the need to focus on order-flow in order to interpret news-flow/information and the interaction of various timeframes. Dalton has effectively said ‘Be an innovator by finding asymmetric trade location.’ Chapter 4 introduces some specific indicators that help point you to figuring out where you are in the acution process. Once you know where you are, you can then begin to recognize reward-risk and asymmetric location. This chapter begins the real meat of the book. Market Profile is an analysis of the ‘structure’ of the market -- where ‘structure’ is different than price movement. For example, any down day that doesn’t have the proper ‘down-day structure’ is likely to have just weakened the short-side and may have just strengthened the case for the innovator to go long. And vice versa, any up day that doesn’t have the proper ‘up-day structure’ will have weakened the long-side by removing buying power and may have strengthened the case for the innovator to soon look to short. An up day with the right ‘up-day structure’ means that while timeframes have begin to come into agreement, the ‘late-majority’ (laggards) have not yet climbed on board. Since the market is said to reverse when the laggards of the last auction meet the innovators of the new auction, the innovator should ‘stay-with’ his position a while longer as the structure suggests continuation. One of the more important aspects to market profile is a careful analysis of what the market did the previous day – and also what the market did in the ‘overnight market’. All of the indicators of market profile relate to one of the following questions: 1. Whatever the market was ‘trying’ to do yesterday – how much conviction did it show in this attempt? 2. Were there signs of ‘higher timeframe’ participation? 3. Given the end-of-day profile structure, is there a recognizable pattern apparent which determines the likely state of inventories across the various timeframes? 4. Did the various timeframes come together and ‘agree’? 5. What was the relationship of time and price for the day? 6. Did yesterdays action ‘weaken’ the market by inefficiently removing buying power (short-squeeze)? 7. Was yesterdays action ‘constructive’ for the market by removing selling power from the market? 8. Should the market trade lower overnight or in the early morning, will encouraged short-sellers be ‘weak-handed’ and subject to a squeeze? 9. Should the market gap-up overnight or in the early morning, will encouraged momentum players be ‘weak-handed’ and subject to a ‘liquidating break’? Indicators #1 & 2: Profile Shape (Symmetric or Non-Symmetric) and ‘Range Extension’ Every auction that is financial in nature is a process that is in search of ‘value’. Competitive forces come together and interact until they are satisfied with the position of their inventory and then they slow-down or stop. This is how ‘value’ is determined. The shape of the distribution (profile) summarizes this activity in its histogram form. There are 4 basic profile structures – with many variations of the primary 4: 1) Elongated Histogram (skinny and long, the histogram looks somewhat like a vertical line ‘|’) 2) Symmetric Histogram (squat or ‘fat and narrow’, the histogram looks like the capital letter ‘D’) 3) The ‘b’-shaped Histogram (the histogram looks like the lower-case letter ‘b’) 4) The ‘P’-shaped Histogram (the histogram looks like the upper-case letter ‘P’) Let’s take the most extreme example as a starting point. If long-inventories are ‘low’ and short-sellers are weak and price is viewed as low by all timeframes, the market profile histogram will ‘elongate’ to the upside, forming a somewhat vertical line (‘|’). Price and time will have a ‘brief’ relationship where price is moving quickly over time in search of satisfying the markets needs (innovators aggressively increasing long-inventories and squeezing the laggards). The histogram that results at the end of the day will be thin. The high-to-low range of the day will expand, called range-extension. What does an elongated (non-symmetric) histogram with big range extension tell you: 1. The late-majority is not on board yet --- you are likely still in the early adopter/early-majority zone of the ‘leader-laggard’ framework 2. Inventories are in the process of adjusting to the various new preferences of the respective timeframes and this process is not yet over. 3. This is a ‘new-business’ led auction. That is, new longs are being established – it is not just short-covering (shorts closing out their ‘old’ positions). The opposite of an elongated histogram is a symmetric distribution. This is when the market is in balance and any attempt away from balance in quickly met with ‘responsive’ buying or selling to push the market price back to value. The time/price relationship will be extended as the market is in agreement on fair value. The histogram will be fat in the middle. Inventories are in-line with how the various timeframes prefer them. Range will not extend far beyond ‘normal’ and may be materially less than normal (narrow range). This is often the case when the market is waiting on forthcoming information such as a fed announcement. The 3rd and 4th profiles are simple but important distinctions from the extreme cases above: the ‘b’ and the ‘P’… I am not going to go into these in depth yet as they are just introduced in this chapter. Other indicators are introduced as well including: Value Area Comparison: Is value being built higher or lower and is value overlapping with previous day or is todays value area noticeably different than the previous day? Initial Balance: this is the first hour range. What happened during the first few 30-min bars? Volume: volume drives acceptance of value. Value can assume to be beginning to migrate if bidding activity is strong. Attempted Direction: Did the market open on one end of the range and make a clear attempt to move directionally?

Chapter 3 ‘Timeframes’ Chapter 3 explores the concept of the distribution of ‘inventory’ among various classes of market participants. Every market that is financial in nature involves the transfer of inventory from one price-conscious party to another. Each party can be classified with regard to how they think about inventory. A long-term investor is by definition ‘committed’ to their inventory of stocks. A short-term scalper trades in and out of the market while targeting zero inventory over any reasonable measure of time. The current price of the market reflects the current preferences of inventory among timeframes. Future price movement depends directly on how the various timeframes ADJUST their inventories. Adjustments to inventories are in turn dependent on how long or short each timeframe is relative to their ‘normal’ inventory situation. Market Profile is intended to structure order-flow to enable the user to ‘read’ the state of inventory and the changes to inventory through pattern-analysis. Dalton has at this point created a multi-dimensional framework to work with: On the one hand, you have many different timeframes of investors interacting and co-existing, creating a complex and dynamic puzzle. On another dimension, Chapter 1 laid out a scale that ranges from ‘early innovator’ to ‘laggard’. I think one way to think about this framework is structured like this: http://www.traderslaboratory.com/forums/attachment.php?attachmentid=5613&stc=1&d=1206416143 ‘Order-flow’ depends on your existing inventory as well as how attractive you view current price. Since the ‘higher timeframe’ (longer-term investors) wield the most buying and selling power in the marketplace, it is their order-flow that is most highly correlated to net incremental inventory changes. Innovators are the ones to figure out when the higher timeframe is actively altering their net inventories and aligning themselves with this order-flow. ~”When the longest timeframe becomes active, it is not uncommon for all other timeframes to eventually join in, which can result in a major trend.” ‘Performance’ depends on how often you are in the ‘innovator/early adopter’ camp vs in the ‘laggard/late majority’ camp. Note the link between the ‘innovator’ and the ‘higher timeframe’ player here. These concepts exist on different dimensions in that the ‘innovator’ may or may not be a higher timeframe player and a higher timeframe player may not be an innovator. Dalton writes that no matter what your timeframe, it is good trade location that is key – and the innovator is the one that figures out good location by examining the inventory/order-flow puzzle of the various timeframes --- and acts on this analysis in real-time.

thanks dbntina, I just loaded this up an hour or so ago and right now my 1-tick chart shows the correct PVP (it matches the highest volume bar that is in my 'Matrix' window) --- while my 2-minute chart is slightly off. I assume that in the future, there won't be this discrepancy (once it has collected the data). I trust that the code is working --- but the 2-minute chart is not right now feeding off the 1-tick chart. is there a rule that you know of where the 2-minute 'catches up' to the 1-tick chart? would be useful to know when the code begins to 'kick-in' and draw off the 1-tick chart. thanks so much frank

thanks, one other thing just so I know. forget VWAP/SD for this question. just pretend I want to watch PVP only. if I have my 1-tick window minimized and my 2-minute chart is up running PVP --- how does the pvp calculation in a 2-min chart know to pick up the data from the 1-tick chart and not vice versa (that is, why doesn't the 2-min data feed into the 1-tick chart if both are open and running the same indicator)?

question dbntina or whomever might know: does the PVP indicator work on historical charts --- or does it need to be collecting data in the 1-tick chart in order to calculate PVP? (and therefore only works on a go-forward basis if that 'data-collection 1-tick chart' is left open)? thanks, frank

Chapter 2 ‘Information’ This chapter is mostly an explanation for why the Market Profile is a powerful tool for capturing the structure of the market. There is a tremendous amount of conflicting information flowing into the marketplace at any given time. Processing this mix of dynamic news-flow in a real-time environment is extremely complex. But what compounds the complexity further is that many different timeframes are digesting the data concurrently. ‘Good news’ might seem bullish to a trader who is not already long the market. But to a big institution with an extensive inventory of long positions, ‘good news’ might lead to aggressive selling. Thus, the nature of the news might very well be inversely-related to the next directional move. Thus, the market is being moved around not so much by the intrinsic nature of the newsflow, its being moved by the NET order-flow of the different time-fames in the marketplace. The patterns in Market Profile reveal which timeframe is currently in control of the market. The Market Profile histogram shows the structure of order flow for a given time-period and the ‘value’ area. It takes strong ‘bidding activity’ for price to move away from an established value area. Thus, a move away from a value area is monitored for bidding activity (volume) and acceptance/rejection. Market Profile will expose the dominant timeframe during this process to the seasoned eye before it is reflected in significant price movement. Strong downward movement indicates that the dominant timeframe (whichever that is at the time) views price as unfairly high and is seeking a new lower value area. Bracketing behavior vs Trending behavior is introduced in this chapter. This is seemingly unrelated to the ‘Information’ title of the chapter. But the point is that current price movement needs to be monitored in the context of a higher-timeframe bracket or trend. A ‘bracket’ implies moves away from value will be retraced. Trend implies new directional movement will prove self-feeding (higher prices attract more buying/lower prices attract more selling).

Chapter 1 “The Only Constant”: Remember the lead-in from the Preface: The objective of investing is to identify asymmetric opportunities 1. Once the majority recognizes that change is occurring, all asymmetric opportunity is lost. 2. An easy way to categorize an ‘auction’ is to classify the participants as either; the leaders (innovators or ‘early adopters’) or the laggards (the ‘late majority’). 3. Auctions complete when the laggards from the last auction are met by the innovators from the new auction. 4. ‘This book challenges you to be an innovator’ 5. People change markets, markets change people 6. The fundamentals of market activity are just as they have always been: price and volume move over time to facilitate trade in the pursuit of value. It really is that simple. Discussion: Chapter One begins as a general discussion about ‘change’ in the asset management business. The authors challenge the reader to be innovators and not followers. Examples of ‘followers’ (ERISA implementers, relative performance/MPT/Style-focus school to the ‘absolute return’ focus) are reviewed. Dalton is setting the reader up here for why the Market Profile is enduring. While change is always occurring in and around the investment industry, it is the pure and unbiased information that comes from the order flow of the market itself that is ‘the only constant’ (Chapter Title). “Despite the astonishing rate of change in the investment world, the fundamentals of market activity are just as they have always been: price and volume move over time to facilitate trade in the pursuit of value. It really is that simple.” (pg 13) The title of the chapter ‘The Only Constant’ --- appears at first to be that of the cliché – ‘the only constant is change itself’. But I believe what he actually means is ~’the order flow of the market itself is the only constant.’ The only way to be sure you are in with the ‘innovator camp’ and not a ‘laggard’ --- is to effectively analyze the order flow of the market itself. Don’t try to out-think the market, just learn to recognize the patterns that accompany whatever ‘change’ is currently occurring.

Top Concepts From The Preface: 1. The objective of investing is to identify asymmetric opportunities. 2. ‘Excess’ occurs at the end of an auction 3. Trade location is the key to controlling risk and taking advantage of asymmetric opportunities 4. Successful investing incorporates both sides of the brain. Pattern-recognition is how you use the right-hemisphere. 5. [The traders] with superior results over the longer-term are those that are flexible and adaptive to changing conditions. Specific trade strategies come and go. But the underlying auction structure is recurring. Discussion: Since this is just the preface, it is introducing concepts which will be developed later in the book. The theme of the entire book, in my view, is that of using the market profile to give you context on determining asymmetric trade location opportunities.

This book by Jim Dalton is among the very best books ever written on understanding trading concepts, in my opinion. I read this book when it came out and have it all marked-up. As I have re-read it, I realize that I really should do a full outline of the book. This thread is for that purpose. I will present what I think are the main concepts for each chapter. If you would like to contribute, please do. But one request, which you may or may not choose to comply with, lets try to keep the thread to just this book review and not with lots of posts that aren't related to actually reviewing the concepts directly from this book. If you would like to contribute along, please re-read the Preface and the First 3 chapters and we will begin shortly.

Sparrow, What you mention about spreads and commissions is important. That said, my post was on the 'structure' of analyzing trading strategies you come up with, not on the execution part. Yes, it is up to you to execute efficiently. My 'expected return' is assumed to be net of commission costs and spreads etc... I am discussing this at the structural level here. Also, I wasn't suggesting this was appropriate for a pension fund. I was merely taking the sophisticated way institutional asset management works and relating it back to trading strategies that we think about every day. For example, say you write a Tradestation strategy that has great back-tested results --- but it has only generated 50 signals over the past 6 years. Well, this strategy appears a lot better than it is. Why? Because of the 'structure' of the formula that I presented above. The more signals, the better -- because you get increased 'diversification' of the variance. Expected return, assuming it is accurarte, is compounded out by squaring the number over the number of trials --- but 'variance' increases only at the rate of the square root of the number of trials (it rises but at a slower rate than the return). Go back to roulette -- this is not an attractive game for the casino in the short-run from a sophisticated money manager perspective -- you could do a lot better with an index fund --- it only gets attractive over many trials. How many trials before it gets attractive relative to others? This is what that formula reveals. The other big takeaway is simply to keep a healthy respect for the market in terms of how hard it is to find a strategy that will have an exceptionally high return. I quote from my text: "The first necessary ingredient for success in active management is a recognition of the challenge."[1] This translates as: the 'return' you expect out of a given strategy should be properly discounted relative to its back-tested results. Finding high-returning strategies is hard -- the competitiveness of the marketplace ensures that. This thread is actually the 'mantra' of the large quantitative-based firms that participate in the markets with billions every day. I am sharing it here because I think as traders, we should all think about our own strategies in the same way. Trust me on this, I know of what I speak. The key is to find strategies that offer high returns that can ALSO be repeated many, many times. If you develop strategies that don't have a high number of trials --- you are likely fooling yourself -- your strategy may be profitable, its just not attractive relative to what you COULD be doing. This is the beauty of that Grinold/Kahn (authors) formula I posted -- you can keep your expected returns reasonable (below the back-tested results) and still seek outsized returns through implementing the strategies that have more bets to them (and therefore diversifying out the variance). [1] "Active Portfolio Management" Grinold and Kahn, 2000

Here is something they teach to Financial Analysts in the Chartered Financial Analyst (CFA) program - I am going to relate this to trading ‘strategies’. This is really about how the 'structure' of analyzing strategies can be approached and why directional signals on 'daily' charts are problematic. Pretend you are the manager of a Pension Fund and you have $30 billion in the plan. You have a team of consultants working for you that basically evaluate money managers and give you recommendations about how to divide up your $30 billion to earn a return that will meet your expected pension obligation when everyone retires. The question is: How do you compare the strategies of the portfolio managers in a structured way? They all have different strategies and you have to choose. This is the quantitative answer and I think the ‘structure’ of the answer relates directly to how you think about trading strategies: Take the game of Roulette for simplicity. For this game, with 37 numbers (18 red, 18 black and 1 green) – the house edge is 1/37 or 2.7027%. How do you evaluate this ‘game’ in a structured way? Well, all strategies are measured by their return in relation to their risk. The variance of a single roll in Roulette is 99.927% making the Standard Deviation 99.963% (the Square Root of the variance). Comparing the return of 2.7 to Standard Devitation of 99.963 gives a ratio that rounds to 0.0x. As a good pension fund manager, you learned on your CFA exam that 0.50 is a good number. Thus, the variance of Roulette is too high to make the return attractive to you relative to what you can get with other managers. But what about if we take the 1-roll restriction off? The story changes dramatically such that owning a Roulette table is FAR better than any hedge fund strategy. Enter the 'Fundamental Law of Active Management' --- which re-works the ratio of return/risk into a more 'research-intuitive' formula: Where the Ratio = [Expected Return * SqRt(Independent Bets available in a given year)] <---- simple The second half of the equation factors in the number of times that strategy can be executed over 1 investment year. (note that the 0.50 benchmark you are using to compare managers is an annual-based number). For 100 roulette rolls, the formula is: =[2.7% * SqRt(100)] =[2.7% * 10] =0.27 <--- still not that great Turns out that the number that gets you a 0.50 ratio is 342 rolls. Thus, if you are allowed to roll the ball that many times, the strategy is now attractive vs the standard rule of thumb. The more rolls, the better. Get up to 10,000+ rolls and you are talking about a strategy that blows away 99% of hedge funds. How does this relate to trading? Well, I think all strategies should be thought of in the same structured way. If you have a strategy that is based on a ‘weekly’ chart – this is not much good. You won’t get enough signals to make the strategy attractive relative to others. EVEN if your ‘edge’ is good. Even a daily chart… the number of signals is limited. The variance will be high relative to the amount of bets that diversify that variance. Thus: There are 2 ways to make your trading better. Find strategies that increase your ‘edge’ --- difficult to do as trading is a very competitive game. Or find strategies that have similar edge but you can repeat them more. The ratio increases with either --- but the ratio increases by the SqRt of ‘bets’ you make. This is all intuitively obvious -- but extremely important. Finding a happy balance that keeps your win-rate (edge) high and also offers enough opportunities to diversify the variance over many independent 'bets'. By thinking about all your strategies in this structured way, you will understand what makes 1 strategy attractive versus another. Comments welcome, Frank

there was no set-up all day today for this. the market was moving 1 deviation at a time and therefore 'self-correcting' along the way.. There was one moment that was really close though and I was watching for an entry but it didn't happen. I will watch to see if this should be included in the set-up in the future (2 std devs and a higher low -- 'turn up in the oscillator).

remember, this is just a scalp. Set-Up for Wednesday Jan 8:

hi, the code comes from a Traders Lab post... Here is the Tradestation code I am presently using (1-min chart is used on ES.D): vars: PriceW(0), ShareW(0), Count(0), VolWAPValue(0), VolWAPVariance(0), VolWAPSD(0); if date > date[1] then begin PriceW = 0; ShareW = 0; Count = -1; Value1 = 0; Value2 = 0; VolWAPValue = 0; end; PriceW = PriceW + (AvgPrice * (UpTicks+DownTicks)); ShareW = ShareW + (UpTicks+DownTicks); Count = Count + 1; Value3 = 0; if ShareW > 0 then VolWAPValue = PriceW / ShareW; {Calculate the individual variance terms for each intraday bar starting with the current bar and looping back through each bar to the start bar. The terms are each normalized according to the Variance formula for each level of volume at each price bar } For Value1 = 0 To Count Begin Value2 = ((UpTicks[Value1]+DownTicks[Value1])/ShareW) * (Square(AvgPrice[Value1]-VolWAPValue)); Value3 = Value3 + Value2; End; VolWAPVariance = Value3; VolWAPSD = SquareRoot(VolWAPVariance); Plot1(VolWAPValue, "VWAP"); Plot2(VolWAPValue + VolWAPSD, "VWAP1SDUp"); Plot3(VolWAPValue - VolWAPSD, "VWAP1SDDown"); Plot4(VolWAPValue + (2*VolWAPSD), "VWAP2SDUp"); Plot5(VolWAPValue - (2*VolWAPSD), "VWAP2SDDown");

This thread is just to publicly evaluate a set-up I have been working on. comments appreciated. I will call it the '2 std devs and a divergence' set-up. Concept: If S&P futures move 2 standard deviations in a direct move (without a decent correction) AND form a momentum divergence (using LBR's 3/10 oscillator) -- then fade the move for a SCALP targeting roughly 1 deviation. 1st example from Tuesday Jan 8: