Trading With Market Statistics I. Volume Histogram

[jperl 11]

This thread and succeeding threads will discribe my use of market statistics as an intraday trading tool. I wanted to write this down some where for my own edification and perhaps introduce some new ideas that have not been expressed before. Perhaps some of these thoughts may be of use to those of you who are mainly interested in price action, and what market statistics implies about it.

 

We are all aware that price action is all about probabilities. One can ask the question, what is the probablility that at any moment in time, prices will move higher rather than lower. To answer this question requires a knowledge of the probability distribution of prices or volume. The shape of the distribution, and where present price is in the distribution function, suggests in which direction to trade. If price is in a low probablility region, enter a trade in the direction of higher probability. If price is presently in a high probability region, don't trade.

 

Sounds simple, but it's fraught with difficulties. Look at figure 1. This is a 2 minute candlestick chart for the E-mini Russell 2000 index futures for June 22, 2007. The volume distribution function is drawn on the left along the price axis with bars extending out to the right. The length of the bar is determined by how much volume was traded at that price. The longer the bar, the more volume traded at that price.

Looks a lot like a Market Profile. In fact Market Profile is a subset of this more general probability distribution function.

Several things to note about it as follows:

1)The distribution of volume is roughly symmetric about the peak volume price occurring at 840.20 (indicated by the red line in the center) with some smaller peaks occurring both above the peak(at 842.30 and 843.60) and below the peak (at 837.20 and 836.60)

2)The distribution shows very low trading volume, in the high price area and low price area.

 

Figure 1

 

I point out this symmetry in the distribution mainly because it is unusual. It doesn't occur very often. More often than not, the peak volume price does not occur in the center of the distribution.

 

I've also shaded in light blue, the region outside what is called the value area for you Market Profile fans. The green region is the value area, the area where 70% of the volume has traded. I suspect that 70% was chosen as the value area because it is close to 1 standard deviation of a normal distribution ( 68.3%). The normal distribution is symmetric about the peak volume price. There have been lots of prognostications about how to trade when price moves back and forth across the value area, especially value areas generated the previous day. For a more or less complete list of these trade setups see the following [thread=175]sticky thread[/thread] or this site

 

Simply entering a long where the volume distribution is low (below 836.60) and exiting the trade when price moves back into the high volume area (near the peak volume price) doesn't hack it, the reason being, that what looks like a low volume area now, could become a high volume area later on in the day. In actual practice, one never knows what the distribution will look like later on in the day.

 

Take a look at figure 2, which shows the same 2 minute chart of the Russell at 12:16 EST, 106 minutes after the open. The peak volume is at 842.30, and the last bar has closed in a low volume area at 839.90. The distribution looks pretty much symmetric. What do you do? You pull the trigger and go long. Would this have been a good entry? Apparently not. Price action drops the market like a stone as shown in figure 3. By 12:34, price has dropped to 835.80. You exit for a loss of 4.1 pts ($410).

 

Figure 2

 

Figure 3

 

So what happened?

What happened was, the distribution function decided to expand. It would evenutally expand so much, that the peak volume price would eventualy move down to 840.20 (figure 1). In fact, you should NOT have taken the trade described above, for reasons which will be mentioned in a future thread, when we introduce the concept of the volume weighted average price, the VWAP in [thread=1990]part II.[/thread]

 

 

JERRY

[torero 10]

Excellent intro. Looking forward to the next post on how VWAP filter out this type of entry. I myself am a big user of volume by price so this should be interesting.

[TinGull 10]

Yes, I definitely look forward to the next installments

[waveslider 10]

Interesting, yes. Seems to me the answer to why a market breaks out of an intraday range lies in the action on higher time frames. Look forward to seeing your analysis.

[Dogpile 10]

Yes, this is a market in balance and it is an attempted 'coil break' away from value. There is a lot more to this set-up though than the distribution -- you had a large, unfilled opening gap yet the put-call ratio did not surge (put-calls generally take off on a big opening gap down) -- you had very negative breadth indicating widespread weakness, volume had been low relative to previous day indicating lack of strong institutional selling --- but then it picked up sharply as price dropped down outside of the 'accepted range' -- lower prices began attracting MORE selling, the opposite of a market in balance --- this is a 'go-with' to the downside.

[jperl 11]

Interesting, yes. Seems to me the answer to why a market breaks out of an intraday range lies in the action on higher time frames. Look forward to seeing your analysis.

 

Want to explain about action on higher time frames waveslider?

[waveslider 10]

Dogpile started into it with examining breadth. Declining issues heavily were outweighing advancing in both price and volume.

 

I keep a screen up with these two ratios illustrated as a histogram. It's a good clue of direction.

 

As far as higher time frames go, I use price channels and another simple method.

 

If the market is trending (making new lows or highs, not expanding-ranging patterns) and it remains in the favorable 1/2 of the trend, then I expect the trend is still intact.

 

That is one way I bias trades. I use a timeframe about 10x as large as the chart I enter on. So I use a 90 tick chart, look for trend on 900 tick chart.

 

In this case, the congestion you noted on the chart above was occurring in the lower 1/2 of the impulse move down. It was also occurring below the 1/2 mark of the counter-trend move higher.

 

Nothing high tech here, I'm just keeping it simple. Sorry this is getting off topic from market profile. My favorite parts of MP are the ability to see a range easily (like we're in now), and the VPOC - which I see as being very powerful.

 

ws

[waveslider 10]

I'd love to hear more about how you use VWAP to bias trades Jerry

[BlowFish 10]

Hi Jerry,

 

Excellent opening post I particularly like the fact your opening described a scenario in a way that would have resulted in a loss (if traded). This is often a far more instructive way of approaching things.

 

You also hit on (for me) one of the key issues for this type of approach deciding whether a market is still in 'balance' so anticipate a revision to the mean, or whether it has gone 'out of balance' and so we anticipate a directional move to a new balance point.

 

Very much look forward to the next instalment.

 

Cheers.

[waveslider 10]

This might be a new thread altogether.

 

According to the market profile chart I am using, price on YM closed the day just about at the point of control. Seeing that this point is also in the middle of about a total of 6 trading days this month, could this be considered some type of balance area?

 

What do the experts say?

[BlowFish 10]

A quick question if I might - do you solely use yesterdays volume for the profile you watch today? Do you add in today's volume as it occurs? Do you ever look at N day volume.

 

Forgive me for getting somewhat specific and technical at this early stage but I have been playing with different sample periods and it makes quite a difference. My personal favourite is probably a 'sliding window' of the last 24 hours from the current moment in time.

 

Cheers.

[Nick1984 10]

Have you considered using regression analysis to give a trading range for the day? If you plot Price against Volume and Time you can run a regression and following some tests for significane of your variables and whether you have unbiased estimators you can gague what the trading range of the day might be.

[jperl 11]

This might be a new thread altogether.

 

According to the market profile chart I am using, price on YM closed the day just about at the point of control. Seeing that this point is also in the middle of about a total of 6 trading days this month, could this be considered some type of balance area?

 

What do the experts say?

Waveslider-

Here is my chart of YM for June 26, 2007-

 

The peak volume price is at 13492, far from the close in the 13390 area. The volume distribution is skewed about 20 pts to the downside.

JERRY

[jperl 11]

Have you considered using regression analysis to give a trading range for the day? If you plot Price against Volume and Time you can run a regression and following some tests for significane of your variables and whether you have unbiased estimators you can gague what the trading range of the day might be.

 

Nick---yes I will get into that when I start talking about the volume weighted average price and its standard deviations. Stay tuned.

JERRY

[waveslider 10]

Jerry - I see, it was my error regarding the close. I should have put a chart up. This 13492 area seems to be carrying quite a bit of weight.

[jperl 11]

A quick question if I might - do you solely use yesterdays volume for the profile you watch today?

 

no

Do you add in today's volume as it occurs?

Yes

Do you ever look at N day volume.

Yes

 

these questions will all be answered in later threads when I discuss the significance of the VWAP. Stay tuned.

JERRY

[rsi77 10]

Could someone tell me which charting package was used to create these charts?

 

Thanks,

 

Ron

[BlowFish 10]

Jerry uses Ensign though there are other packages that will do the job.

[rsi77 10]

Thanks,

 

The screenshot he showed looked very nice. I think Ensign isn't too expensive, and it works with Infinity AT, so maybe I'll give it a try.

 

Does TS do this same thing well? If so do you know the indicator name?

 

thanks again,

 

Ron

[BlowFish 10]

Hi Ron,

 

If you peruse the markets stats threads you will come across indicators for tradeststation posted by Dbtina. Several packages can do what you need.

 

Cheers,

Nick.

[rsi77 10]

Thanks Nick,

 

I found one of the indicators, and I will keep looking for others. It seems this could be very useful.

 

Ron

[jperl 11]

Thanks,

 

The screenshot he showed looked very nice. I think Ensign isn't too expensive, and it works with Infinity AT, so maybe I'll give it a try.

 

Does TS do this same thing well? If so do you know the indicator name?

 

thanks again,

 

Ron

 

Ron, before you get too deep into TS, you might want to check the new thread by Frank in the [thread=4230] coding forum [/thread]concerning TS and market profile problems.

[rsi77 10]

Jerry,

 

First of all thahks for your posts--very informative. Secondly, are the ensign indicators that you use available with the software, or did you develop those by yourself?

 

Thanks,

Ron

[jperl 11]

Jerry,

 

First of all thahks for your posts--very informative. Secondly, are the ensign indicators that you use available with the software, or did you develop those by yourself?

 

Thanks,

Ron

 

The volume histogram is available in Ensign. When I started these threads, VWAP and SD were not available, so I wrote them myself. Now both are available in Ensign.

[akifusenet 10]

Hi Jerry and everybody here at TL,

 

As this is my first message I think first I have to say that TL is the best place(information wise and attitude-wise) about trading which Ive seen upto now.

 

I began to read your threads (i am now at part2). While I was reading I want to practice on demo also to make things concrete. I am using MT4 platform which is in these days quite popular/easy to use and free.

 

But I couldnt find any Volume histogram indicator (especially on y-axis which you have in your ensign charts) or any PVP indicator. I managed to find a VWAP indicator. For PVP and volume histogram I think I can use the MP indicators as a base and modify them to use volume instead of price but that means digging into MQL files which I dont want to do right now. (eventually it will happen later i think).

 

So it looks like the MT4 crowd hasnt discovered you yet. Do you(or anybody here) have MT4 indicators for your tutorials (including future parts which I have not read yet). That will be great for me to start up.

 

I think Chimp is using MT4(Ive seen a video from his thread).Maybe he has them in his arsenal.

 

Again thank you Jerry for your all efforts which I am just discovering...

 

 

Akif,