Price Discovery

[bojangle 10]

I don't really know a lot about price discovery and auction market theory, but i really want to learn about it. From what i understand is that price is always moving until it can find two-sided trading. It will test level after level to find it. I plan on posting charts in here starting tonight. I appreciate all the help i can get from experienced traders. Thanks.

[bojangle 10]

What levels will price test? most accepted and most rejected areas of the past daily profiles would seem likely, just because they are the most obvious ones. so here is a chart with the most accepted and most rejected prices from monday's regular hours trading sessions. i see that price goes from one level to the next, but i don't know why... there must be a simple way to state what is happening. can someone give me some input? thanks.

[bojangle 10]

Levels for tomorrow's trading. Plotted the most impressive ones, but some high volume levels are not plotted and could stop price i guess, so i have to keep an eye on them.

[StevenSJC 10]

It has always amazed me over the years of trading and observing how often markets reverse, pause, oscillate around these various key levels. Obviously there's a massive group think/psychology at work. Meaning hundreds/thousands (?) of other people trading the market have marked the same levels or close -- and it becomes a self-fulfilling prophecy.

 

It's why still to this day I'm paranoid about entering just ahead of big round numbers, or other key numbers in the markets I trade because still, despite all the thousands of trades running across they still respect them.

 

Of course, they all eventually break - in seconds, in minutes, in days -- but there's definitely opportunity working around them.

 

I'll look forward to seeing more from you.

[ant 10]

Increase your timeframe and observe longer term (more reliable) references. These are the references where multiple timeframes get involved, not just day traders. Translation: Bigger Opportunities.

[chulaihuey 10]

Thanks for starting this topic. I am trying to learn Auction Market Theory as well, so I cannot add much right now.

I am reading Auction Market Theory now as an introduction and to better understand it.

I look forward to posts in this thread and will add if and when I feel I have something useful to contribute.

[bojangle 10]

I'm not seeing much reliability in the day timeframe's levels. I don't know what i'm missing or what... i can't figure it out. maybe i should look for price areas that are more important to the longer-term traders who actually drive the market... but how? finding volume levels based on a time period doesn't seem right... anyone have any suggestions? thanks.

[tastypaint 10]

the time frame to look at is days of overlapping value. the nodes with the most volume are your s\r areas.

[ant 10]

bojangle,

 

Below is a daily and 30min chart of the ES and the type of reference areas that I mark off everyday. I think my view of the market is self explanatory from the charts so I won't add any more text. Hope this helps.

 

 

[MadMarketScientist 11]

Would be interesting at end of day for you to take a look and recap how it reacted around those key levels if you can.

 

 

MMS

 

 

bojangle,

 

Below is a daily and 30min chart of the ES and the type of reference areas that I mark off everyday. I think my view of the market is self explanatory from the charts so I won't add any more text. Hope this helps.

 

[ATTACH]22897[/ATTACH]

 

[ATTACH]22898[/ATTACH]

[steve46 12]

To original poster

 

Over a period of years, what I have found to be true is that most traders want to find a principle or an organizing concept that;

 

1. Allows them to make consistently accurate judgements about market direction and

2. Shows them where to obtain favorable entry

 

In truth, what they really want is relief from the psychological tension caused by uncertainty. In other words, the retail trader (newbie) is generally ignorant about the markets, hasn't learned the basics about the financial system he/she is going to become involved with, and hasn't done enough research to find a systematic approach that provides a tradeable edge.

 

Personally I would be uncomfortable too and looking for answers.

 

The price discovery process is simple, Traders offer and traders bid for, stock or futures contracts and in the process they "discover" whether the price they want to transact is too high, or too low. Human nature being what it is, sellers believe that what they own is valuable and want more for it, than buyers want to pay. On the other side, if the stock or the futures contract weren't of interest to buyers, then they wouldn't be offering ANY price, would they? So the question is at what price is a product (stock or futures contract) fairly valued. Generally speaking, fair value is what a knowledgeable person is willing to pay at any point in time for the product. Here the question of time comes into play...According to Auction Market Theory, time effects the way people think about value. If for example the markets have just opened, most folks would agree that they have plenty of time to figure out what a fair price is for a share of stock, or a futures contract. However, if you have a systematic approach that requires you to buy or sell at the opening price, the idea of price discovery goes out the door. Same for traders who, near the end of a market session find themselves holding position that they need to "cash out". For those people, no matter whether they have a potential profit, or loss, the limitation imposed by "time" is going to motivate them to pay up or accept the current offer, whether they think it is "fair" or not.

 

Its an interesting subject, and one that people generally neglect to learn about.

 

In terms of a profesional approach, what I have observed is that learning about and taking full advantage of human nature (and that includes the price discovery process) CAN provide a valuable edge that you can use to make money in the markets. I use that edge in my business every day. Clearly I am biased in this, but I have to say, this principle works better than technical or fundamental analysis and since human nature isn't going to change anytime soon, once you understand, you simply continue to use it (no periodic software updates required)...

 

In addition to the subject of price discovery, the principle of supply and demand are vital to leaning how to make money in the markets. Once you learn to understand and integrate these ideas, you have the opportunity to exploit markets.

 

Attached is the chart I worked from last night. I use two (2) simple concepts to make a buck...time and price and the discovery proces is embedded in each one.

 

Good luck

[Kiwi 16]

In terms of a profesional approach, what I have observed is that learning about and taking full advantage of human nature (and that includes the price discovery process) CAN provide a valuable edge that you can use to make money in the markets. I use that edge in my business every day. Clearly I am biased in this, but I have to say, this principle works better than technical or fundamental analysis and since human nature isn't going to change anytime soon, once you understand, you simply continue to use it (no periodic software updates required)...

 

In addition to the subject of price discovery, the principle of supply and demand are vital to leaning how to make money in the markets.

 

 

This is technical analysis. And to be commended. My charts and areas of interest look very similar to yours although my underlying beliefs might just be different.

 

"While fundamental analysts examine earnings, dividends, new products, research and the like, technical analysts examine what investors fear or think about those developments and whether or not investors have the wherewithall to back up their opinions; these two concepts are called psych (psychology) and supply/demand. In the M = P/E equation, technicians assess M, the multiple investors do/may pay - if they have the money - for the fundamentals they envision. Technicians employ many techniques, one of which is the use of charts."

 

That source of pretty much everything you need to know

[snowbird 10]

Steve46,

 

What is the overhead supply, and "offset" supply, and what do you mean by retail/wholesale limit?

 

Ant,

 

Are you considering each box a period of auction, and "excess" is similar to what Steve46 calls "offset supply?

 

snowbird

[ant 10]

Would be interesting at end of day for you to take a look and recap how it reacted around those key levels if you can.

MMS

 

See figure below for potential trades today. One thing worth mentioning is that context is important to consider along with the reference levels.

 

[ant 10]

Ant,

 

Are you considering each box a period of auction, and "excess" is similar to what Steve46 calls "offset supply?

 

Snowbird, I view the markets in terms of brackets, breakouts, and trends. It's how my trading mind works. When I first started trading, I used to view the markets as a momentum trader and only focused on trends and pullbacks. Anyway, each "box" in my chart is a trading range. While in a trading range, I look to fade the extremes, generally speaking. Excess usually marks the end of an auction and the beginning of a new auction in the opposite direction. So yes, that is an area where supply/demand came in. Auctions don't have to end with excess, volume can simply dry up in the current auction. But as you can see, up/down auctions usually end with excess. As Dalton says, excess and balance are probably the two most important concepts that MP traders deal with. When I draw the "box" around a balance area, I try to let the excess stick out of the "box" to remind me that the auction might be over. Eventually, the market will break out and auction higher or lower until two-sided trading is found. It can also fail to breakout and re-enter a previous balance area. This is one of my favorite trades because the risk/reward is usually excellent. The market condition (balance, breakout, trend) helps me determine my trading tactics for the day. But as a trader, if the market starts to do something different than I expected, I have to adjust my thinking - not easy to do obviously. IMO, to have a chance at succeeding at trading, a trader should have a model by which (s)he frames out the market that is based on sound principles. This is mine. Hope this helps.

[steve46 12]

In answer to your question Snowbird,

 

"Overhead Supply" refers to an area above the current price where inventory is parked. The term "Offset" refers to a second area of supply adjacent to the "overhead" supply.

Edited November 13, 2010 by steve46

[ant 10]

I thought I'd share my analysis for Monday, 11/15, to continue this discussion on price discovery and reference levels going. Here it goes...

 

The following is a daily chart of the ES. It shows the ES trading near the top of the previous balance area (1193) and Friday's potential excess.

 

 

The next chart shows the previous two balance areas with important reference areas. Note that I have not included Friday's trading in the most recent balance area since it closed outside the balance area. However, if the ES starts trading back into the balance area (above 1202) next week, I will consider it part of the balance area (i.e., Friday will have extended the balance area) and Friday will most likely be considered excess with a new up auction beginning. The chart also shows a b-shaped profile for Friday's trading indicating that trade is not being facilitated lower. The POC was 9 TPOs wide, which I consider to be prominent, which means that it could get revisited on Monday.

 

 

The final chart looks at Friday's trading in more detail. It highlights the rally high, single print, and poor low.

 

 

Here are my potential trade scenarios for Monday:

 

If the market opens within value...

• I would consider going short at the rally high with the expectation of the prominent POC and poor low being revisited. Staying below the rally high keeps the short-term downtrend intact.
  
• I would consider going long in the 1191-1193 area, which covers Friday's poor low, the previous balance area high at 1193, and the lower trendline. Also keeping in mind that Friday's profile was b-shaped. I would really like to get a peek-a-boo below Friday's low to see if there are any more sellers and to correct the poor low.
  

If price is accepted below the 1991-1193 area, I would look for a short entry since it opens the possibility of trading to the opposite end of the balance area.

 

If price is accepted above the rally high and single, I would look for a long entry since that would confirm that Friday as being excess, which I would consider to be the start of an up auction. Once we start trading into the most recent balance area, the market may take a shot at the most recent highs over the next few days.

 

Once in a trade, I will use all the other reference areas to scale, manage the trade, and enter new positions. Also, prior to the market open on Monday, I will review the O/N trading, observe where the market will open, and the monitor the confidence level at the opening. I will then review my trading plan once again. Note that I try to put together a story to support a trade. I usually do not use a single data point to justify a trade, but I do have a few exceptions.

Edited November 13, 2010 by ant

[bojangle 10]

I've been looking at charts and have been using the boxing method to find s/r. Instead of time based charts, i've been looking at constant volume based charts cause it just makes more sense to me. helps see the larger rotations that the smaller rotations make. these things together have given me the sight to start a trade play-book of trading scenarios for the day. i used to look at the constant volume bars a while ago, and i seem to always come back to them. they really are a great visual of how volume is distributed across prices. for some reason reading the volume profile was a challenge for me. these bars easily show price acceptance building higher/lower.

Edited November 13, 2010 by bojangle

[steve46 12]

One thing I would suggest (and I do so humbly)....is that referring to charts and leaning on methodolgies are part of the trader's natural preference for psychological comfort. and while these methodologies may indeed provide a good "way to go", the" big players", couldn't give a damn less about Market Profile, Channels, Boxes, Moving Averages, Fib Retracements and so on. What they DO give a damn about are the answers to questions like "How will a big move up (at this time of year) affect our tax reporting? "How much inventory do we have at risk (and where is it located in reference to current price)?" and the big question for institutional participants.."How close are we to our P&L targets for the year, quarter, month"?

 

Given that orientation, I expect the big players (AKA "the market") will try to find support early in the month (next week)

and from that point, launch an extended up move into the New Year. This scenario allows the big firms to defend existing profit and inventory, and insures that they receive those nice end of year performance bonuses.

 

For those who might have an interest

 

We opened the year at 1113.75, the high to date 1224.75, and the low 1002.75

We opened the quarter at 1135.75, high to date of 1224.75, and the low 1127.00

We opened the month at 1186.25, high to date of 1224.75, and a low of 1173.75

 

Good Luck

Edited November 13, 2010 by steve46

[steve46 12]

Sorry my time limit ran out before I could finish my post. I would guess that 1186 is the "line in the sand" for my upside scenario to play out. If this is going to happen, I am guessing that the market will reach down to test that price, maybe "shake the tree" by taking it out by a point or two (no lower than 1183.25), before retracing back up (leaving some folks trapped short), and continuing into the New Year.

 

So now we will see

Edited November 13, 2010 by steve46

[ant 10]

I agree with much of what Steve has written in this thread, but I'd like to add the following. I agree that the "big players" or longer term traders/investors don't care much about the reference levels that most traders use. But for me, reviewing longer term bar charts, reviewing Market Profile, and applying market logic is an effort to understand what is happening in the market so that I can try to align myself with the dominant player. That is, who is dominating the market on any given day, short-term traders, longer term traders, or both? Whoever the dominant player is, I want to play their game. On those rotational type days, where the market is being dominated by short-term traders, "good" reference levels tend to hold. But when the market is being dominated by longer term traders, those same reference levels get mowed over many times. This is why context is so important in trading and helps with determining trading tactics and devising one's trading plan for the day. This is where my trading edge is - understanding market behavior and adapting to the current market behavior. Am I always right? Of course not.

 

Longer term bar charts and Market Profile provide me with a roadmap as to what is the market condition, who is dominating the market on any given day, where are the longer term traders/investor likely to enter the market, whether inventory is getting too long or too short, where the "destination trades" might go, etc. I always, always, always want to align myself with the longer term players above anything else. Otherwise, I'll play the short-term trading game. And yes, all timeframes are usually in the market on any day, but the question becomes to what degree. In general, I want to align myself with the "big players" and fade the retail trader.

 

IMO, identifying the different timeframes in the market is critical for traders to succeed over the long-term, but it's tough to learn and requires a lot of experience. Reference levels alone do not give an edge, although this is where most newbies focus their efforts because it is easy to learn, again IMO. I'm a strong believer that if you want to fail at trading, just do what everyone else is doing. It's logical if 90% or so of traders fail. Traders usually come up with similar reference levels using different approaches (i.e., Fibs, PP, moving averages, Market Profile, etc.) and blindly fade them without considering market context. Good luck with that! Much of trading success also has to do with trader feel and considering market tempo and the confidence in the market. My trading framework, influenced mostly by Dalton and Wyckoff, has done well in putting me on the right side of the market on most days that I trade. After that, it's a matter of playing the odds of how the market may play out given my interpretation of what the market is doing in the timeframe that I am trading. And, trying to find good trades with good trade location and excellent risk/reward.

 

I'm sure others will disagree with me, but hey, that's what makes a market. Thus far, this is where my journey has taken me. As I gain more trading experience, some of my assumptions will change, but I don't expect [hope] that my framework will change much. Sorry if this post comes off like a lecture, I just have confidence in what I do, and that tends to come out in my writing. I respect all differing viewpoints and enjoy reading them, which is why I still visit trading forums.

[steve46 12]

I would suggest the following (and I hope people will believe me when I say there is no ego involvement in this at all). The S&P futures market is dominated by professional interests. Retail participants (investors, traders) took a beating a while back (as many did) and they haven't come back into this market. Also the math is simple. The small lot participant is ussually late to the party and simply doesn't have the horsepower to move this market. The Market Profile concept of rotation is still valid, because on specific days, institutions simply stop moving inventory. On those days (marked by low volume) the smaller funds and the aggregate influence of small lot participants can be felt, but in my opinion, they don't have the ability to project a sustained move. On those days if you are observant, you see the effect of programmed execution, as the futures move in very specific ranges (that market profile characterizes as "horizontal development").

 

So what to do? Well if you have the skills, one way to trade those days is to read the tape (and here we get to the limit of "where I can go" with my commentary) by "tape" I mean the "time & sales" strip, "market breadth" and the "NYSE tick". Thats how I was taught. and of course at this point we get into the philosophical issue of who knows how to do this, can you get training, what does it cost (I can assure you I am not involved in any type of training). etc. Its difficult. Absent a skilled pro willing to teach it, I would say your best option is observation and screen time.

 

Its a good day. My back is healed well enough to walk finally and no more pain meds (miss them already lol) so although I bear no resemblance to Elvis, I am going to "leave the the building" so to speak. Theres not a lot more I can say really (without getting fired). It was nice to have the opportunity to share some ideas. I hope everyone has a nice holiday season.

 

Good Luck

Edited November 13, 2010 by steve46

[bojangle 10]

when i read over steve's posts i am thinking to myself that i am making a mechanical method out of the market. "cluster of bars = support = buy". i don't ask myself "why price has stopped here?" single lot traders can't do that. large traders obviously control the market and they hold onto their positions long-term, basing their trading on the only factors that have a long-term impact: the economic info. if we stand back, we can see where they entered, where they put on positions. levels created by day traders can't be reliable. most likely larger traders with size are watching these levels and screwing over all the day traders who establish positions at them. i just don't know, but i'm not approaching trading from the right angle. i get lost in the noise, which is what larger traders probably want to happen. there's just no information at all available anywhere on this subject but the few scraps the professional prop. guys decide to give to the retail crowd. i'm looking at a plane, and i'm seeing a milkshake.

 

i'm not stating any facts here and i know a lot of what i said can be questioned. i'm just trying to figure it out and my ego isn't on the line.

[steve46 12]

"Just when I thought I was out, they pull me back in"....hahaha..the only line I remember from "The Godfather" with Al Pacino?....OK one last time

 

Bojangles...lets understand each other....I think I can say this with a lot of confidence. Institutional traders have no interest, none whatsoever, in what retail traders are doing, where they are entering trades, or where retail stops are...none....In order for us to be interested in what retail traders are doing, there has to be something in it for us....and there just isn't enough return (under current conditions) to justify it....you see? So please understand, we don't look to run stops, we don't look to run over your "levels"...it just doesn't work that way....

 

So we can have a balanced comment, you should understand that some folks ARE interested in what you are doing....If for instance you were to talk to a floor local, you might see that periodically THEY like to run stops (everybody's stops). If you had the chance to talk to someone programming auto-execution bots, you might see that some of these automated programs do in fact search for resting orders (they try to activate resting orders to generate momentum). So there are things going on under the surface and THAT is why UNDER NORMAL CONDITIONS the concept of rotational days (and other market profile concepts) still works (although in my opinion, not as well as it used to).

 

Can I go now? (don't make me come back here lol)

[ant 10]

If the market opens within value...

• I would consider going short at the rally high with the expectation of the prominent POC and poor low being revisited. Staying below the rally high keeps the short-term downtrend intact.
  
• I would consider going long in the 1191-1193 area, which covers Friday's poor low, the previous balance area high at 1193, and the lower trendline. Also keeping in mind that Friday's profile was b-shaped. I would really like to get a peek-a-boo below Friday's low to see if there are any more sellers and to correct the poor low.
  

 

Here were potential overnight trades based on the above analysis. Note that these were discussed for the regular trading hours, but if they set up overnight, they are still valid trades. Overnight session opened within Friday's value area.