141 West Jackson - A Journey Through Trading Discoveries by Copy

141 West Jackson

A Journey through Trading Discoveries

r J. Peter Steidlmayer

Steidlmayer Software, Inc.

Chicago, Illinois, 1996

Copyright © 19961. Peter Steidlmayer

All Rights Reserved.

Reproduction or translation of any part of this work beyond that

permitted by Section 107 or 108 of the United States Copyright Act

without the permission of the copyright owner is unlawful. This

publication is designed to provide accurate and authoritative infor

mation in regard to the subject matter covered. It is sold with the

understanding that the publisher is not engaged in rendering legal,

accounting, or other professional service. If legal advice or other

expert assistance is required, the services of a competent profes

sional person should be sought. From a Declaration of Principles jointly adopted by a Committee of the American Bar Association and a Committee of Publishers.

Printed by: Litho Art Printing· 60 I SE Clay St . • Portland, Oregon

97214

Market Profile® is a registered trademark of the Chicago Board of

Trade.

Library of Congress Catalog Card Number 96-72352

First Edition

Printed in the United States of America

To Kirby-whose sense of order was complete and wonderfully

infectious.

Preface

It has been an interesting journey. Over the past fifteen

years, I have seen Market Profile evolve from an objective

output which required a fair amount of subjective input, to

what we have today, a Market Profile digital database that

helps to objectify the market. Over that same time horizon, markets have become more international, interconnected, and

complex. The challenge to the individual trader has become

more daunting. The influence of external markets and today's

capital flows would tax the market understanding of the most

successful intuitive trader of the past. To deal with the ava

lanche of the information age and remain objective and there

fore in control as a trader requires new tools.

When reading this book, approach it as you would any

mental exercise. Look to gain knowledge, and consider how

you could apply the concepts presented to your trading. Don't

see it as a how-to book that contains the Holy Grail. The way

Mr. Steidlmayer offers his insights, thoughts, and observations

as public domain is surely selfless and exemplary. He is a

visionary who has conveyed a lifetime of thoughts and ideas on

markets into one all-encompassing manuscript, 141 West

Jackson.

Steven B . Hawkins SBH Capital Management

December, 1996

Acknowledgments

In this book there are many uses of both the singular and plural in describing developments. Sometimes it's I, sometimes we

or us, depending on the way I just naturally felt about what took

place at that particular moment. I 've been fortunate to have a lot

of help throughout this project, including especially the full sup

port of all those associated with me as well as those who be

lieved in me. It would be proper to acknowledge each person

who was involved individually, but the contributions came from

the whole Market Profile community, and that includes almost

everyone I 've dealt with. I would like to single out the person

most responsible for the existence of Market Profile: the former

Chairman of the CBOT, Les Rosenthal . Leadership, unlike stew

ardship, calls for having a sense of direction, and more impor

tantly a clear perception of how to let things proceed. To all of

you who participated, I 'd like to express my thanks for a very fun

journey, and for your efforts in helping to make what I feel is a lasting contribution to the industry.

It is always difficult to find a clear way of expressing radically new ideas. And expressing myself is not my strong point in

any case. I'd like to particularly thank my editors, Cynthia Brown and Robin Mesch, for their truly brilliant transformation, or perhaps I should say transmutation, of my rough manuscript into its

present polished form.

1111

Background

When I graduated from college and first started trading, my

father asked me why I would want to get into a business where

almost everyone loses. My answer was that there wouldn't be

much competition.

Despite my bravado, I knew I would need to overcome formi

dable obstacles on the path to my goal. Most importantly, I real

ized I was working against a background where the accepted prac

tices were not making other people successful. Because of my

experience in school, I was confident that I could learn how to

learn. I also knew it was important to keep the learning process

separate from making money. To me, what others regarded as

success, whether it was immediate financial gains, or the good

opinion of others, was not real success, because it might not have a real foundation. The foundation for being successful was in the

learning; the real definition of success was improvement in my

ability to function, improvement in my performance as compared to the background of what I was before. I felt that most people

didn't take the time to learn and didn't make a commitment to keep learning once they began to make some money. The path I

was going to take was one where I would question everything I

did.

One factor in my decision to become a trader was my experience outside the Chicago Board of Trade (CBOT) in trying to get

into other businesses. I had what I thought were a lot of good

ideas, but I had a hard time convincing people in power to go

along with them. In other words, I got the old "Well son, when

x

you have a lot of experience come back and see me," attitude. I was terribly frustrated. I could see that it would be a long time before I got the opportunity to use my capabilities in the business world. I began looking at the CBOT markets as a place where

my ideas could hatch. I wanted to become an outright trader, rather

than a broker, a spreader, or a scalper, because I felt that was the

highest echelon one could achieve: it had a limitless potential. If

I couldn't succeed as a trader, I was willing to leave the industry

and try something else.

The path I eventually developed for myself was rather unor

thodox at the time, and, because of my preference for market

controls over financial controls (ideas I ' ll explain later) and my

insistence on the need for the industry to change, it is still very

controversial. However, in view of the lack of success of the cur

rent methodologies, logic would say that change is necessary.

Over the years, as I worked to become a successful trader, I

kept returning to my father's question, wondering why so many

aspiring traders fail . I have come to believe that consistently suc

cessful trading requires a grasp of the underlying processes that

drive the market, at least on an intuitive level. Successful trading

has to emerge from an understanding of the background of the

market. My goal has been to make that understanding explicit,

and to make the processes objectively measurable. The tool I 've evolved and used in this endeavor is the database and market

analysis system called Market Profile. This book is the result.

Contents

Chapter One

What This Book is About ....................................................... 1

Chapter Two

Getting Started ........................................................................ 7

Chapter Three

Market Discipline, Background, and Efficiency ................ 21

Chapter Four

Looking for the Purpose of the Market .............................. 33

Chapter Five

Efficiency and its Role in Market Organization ................ 39

Chapter Six

How the Market Defines Itself ............................................. 55

Chapter Seven Capturing Market Data ....................................................... 61

Chapter Eight

The Importance of Two-Dimensional Expression ............. 65

Chapter Nine The Bell Curve ...................................................................... 75

Xl

xii

Chapter Ten Updating Our Understanding of Market Profile ............... 79

Chapter Eleven

Looking to the Future--Data Arrangement ...................... 103

Chapter Twelve

Price ... The Market Messenger ........................................... 125

Chapter Thirteen

Where Do We Go From Here? .......................................... 127

Index ...................................................................................... 133

CHAPTER ONE

What This Book is About

Studies of the commodities markets consistently show that

85% of all traders lose. I 've begun trading stocks in the last couple of years, and interestingly, if you measure the results of stock

mutual funds versus a standard index, the success ratio is simi

lar: approximately 85% of all stock funds failed to beat the S&P

last year. The "trading" activity in a stock fund is stock picking.

It is quite revealing that while most commodity traders are tech

nically oriented, and most stock pickers rely largely on funda

mentals, their trading results are quite similar.

Why do such diverse approaches lead to equally sub-par per

formances? What is the common denominator? The answer that

I initially gave myself, and which I still believe is correct, has to

do with understanding, particularly in terms of market back

ground. The programs of both types of traders seem to eclipse

background; in the case of the technical trader with financial con

trols, and in the case of the fundamentally based trader with a

belief in projections. A trader must try to understand a market in the present, rather

than attempting to predict the future. I think that what follows in

this book will go a long way towards solving this problem. The crux of why people are losing is that they are using the wrong database, one that actually inhibits the necessary insights from

2 CHAPTER ONE

PRICE TOTAL CTI 1,2 CTI 1,2% CTI4 CTI 4 %

58-15 50 17 34 33 66 58- 1 4 387 247 63.8 140 36.2 58-13 594 381 64. 1 213 35.9 58- 1 2 1530 916 59.9 6 1 4 40. 1 58-11 2632 1630 6l.9 1002 38.1 58- 1 0 3288 2092 63.6 1 196 36.4 58-9 5239 3348 63.9 1 89 1 36.1 58-8 3696 2166 58.6 1530 4l.4 58-7 3232 1804 55.8 1428 44.2 58-6 278 1 1910 68.7 871 3 1 .3 58-5 21n 1391 64 781 36 58-4 2019 1350 66.9 669 33.1 58-3 2635 1 7 1 4 65. 1 921 34.9 58-2 3626 2454 67.7 lIn 32.3 58-1 5543 3462 62.5 2081 37.5 58 6434 3989 62 2445 38 57-31 3849 2360 61.3 1489 38.7 57-30 5136 3 1 93 62.2 1943 37.8 57-29 3952 2627 66.5 1 325 33.5 57-28 3674 2441 66.4 1233 33.6 57-27 2206 1317 59.7 889 40.3 57-26 2582 1681 65. 1 901 34.9 57-25 2078 1 288 62 790 38 57-24 1 317 699 67.2 618 32.8 57-23 1040 622 59.8 4 1 8 40.2 57-22 9 1 9 586 63.8 333 36.2 57-21 639 404 63.2 235 36.8 57-20 977 582 59.6 395 40.4 57- 1 9 473 258 54.5 215 45.5 57-18 87 76 87.4 II 12.6

Table 1-1. Bond trade volume by categories, Oct. 6 1981

developing, and thus blocks them from learning about the mar-kets.

Internal market statistics reveal that successful traders, who are mostly concentrated among the professionals, are using a dif-ferent strategy than unsuccessful ones. Table 1- 1 gives volume

Top 1 /3

Middle 1 /3

Bottom 1/3

WHAT THIS BOOK IS ABOUT 3

CTIl, 2 CTI4

59.4 (62.9)

64.5 (62.9)

64.2 (62.9)

40.6 (37.1)

35 .5 (37.1)

35 .8 (37.1)

Table 1-2. Trade percentages summarized by categories

statistics for trading in bonds on October 6, 198 1 . It was issued

by the Chicago Board of Trade in an attempt to help the trading

public by providing information on the various types of market

participants. At that time the volume data was broken down into

segments of CTI codes (Commodity Trader Identification codes,

such as commercial trader, local, local off floor, and other); CTII

and CTI2 are the local and professional trader categories, while

CTI4 represents all others (CTI3 was not used).

The total percentage of trades for the local and professional

traders is 62.9%, with the remainder going to the others . If both

categories of traders were trading the same way, then the

percentage columns would read 62.9% and 37. 1 % all the way

down the table. Clearly, this is not the case. To get a better idea of

what's going on, let's average the percent of trades for each

category in the top, middle, and bottom third of the table. The

result is summarized in Table 1-2.

Note that in the top third of the range the CTI4 traders are several percentage points above their 37. 1 % average, while in

the middle and bottom third they are several percentage points

below it. The implication is that the market is extracting a pre

mium from this type of trader for the potential opportunities presented. The CTIl and CTI2 traders have the reverse effect; they are not paying the premium because they are trading the efficient

part of the market that the trades are going to emanate from. The

4 CHAPTER ONE

implication is to move your trades to this part of the range as well. The lesson here is that successful traders have an understanding of the market that produces a different strategy than that used by unsuccessful traders.

A great deal has been learned about markets since 1 982, when

the original version of the Market Profile data management and

analysis system was first formalized. The initial effort was based

on the notion that the bell curve, a fundamental organizing prin

ciple in statistical analysis, would have some important relation

ship to market behavior. While not perfect, the first version was successful enough to inspire an ongoing quest to understand more.

Progress was incremental and relatively slow, as learning came

from observation and experience, contributed to by many people in an open process of exploration, discussion, and discovery.

Many of the key formats used in organizing the data were

fortunate discoveries that proved to have important ramifications

far beyond what we intended when we first developed them. When

we went back to try to understand why the formats worked so

well, we were led to the operating principles of the market. The

original formats, which were based on an intuitive understand

ing of trading, had in them the seeds of the formal knowledge we were seeking. It took 1 5 years of working with Market Profile to

develop all the insights. Towards the end, progress was greatly

accelerated by using a computer to do the processing, allowing us to work out and verify our ideas on many more markets than

we could have dealt with otherwise. In fact, bringing the com

puter into the world of trading has accelerated the flow of infor

mation and hence the evolution of the markets and of trading

methods in general. With new types of data arrangement, the com

puter allows quicker forward movement. Change enables the success of people just entering the markets, as a new technique al

ways offers opportunity to the new person. Our most important innovation was the data entry system it

self. Its key advantages were that it allowed us to get away from using chronological time as a basis for organizing our data, and

WHAT THIS BOOK IS ABOUT 5

forced a two-dimensional data representation, giving us a verti

cal base for data processing. This system got the effort of data

organization off on the right foot and gave us a solid basis for

going forward.

Over time, the data entry system evolved from daily profiles

into profiles organized around market events, and finally to a

database of smallest meaningful data units. The system accom

plished the graphic capture and display of the market in a two

dimensional setting that reflects the underlying market processes.

This is a clear prerequisite for obtaining objective measurements

that define the state of the market, and thus the opportunities that

may be present. Markets measured means markets defined. De

fining your opportunities in terms of market measurements is as

close as you need to be.

The culmination of our studies was the discovery that the

market is a dynamic, self-organizing system that is based on effi

ciency. The market is always trying to make order out of disor

der. It has a well-defined underlying process that can be under

stood and recognized, and that process has a natural progression

that can be seen and measured. It has reference points, which,

when identified, represent important information, and it produces

a final output or resultant, which accomplishes the market's pur

pose. The process is cyclic: it reaches closure and then starts over

again.

Finding the market's purpose was our most significant break

through, and it is the central theme of this book. Our explanation

of the market's fundamental process reconciles the notion of mar

ket efficiency with the ability of skillful traders to make money. (In an efficient market, price moves immediately to reflect value.

Thus, the cost of information outweighs the profit potential from

having it.) The idea of efficiency has a long association with markets, mostly conceived as a barrier to successful trading, and

it has been a revelation for us to note its importance as a dynamic resource for traders.

The various stages of the development of Market Profile through the years reflect our increasing understanding, as well as

6 CHAPTER ONE

actual changes in the markets . Throughout the process, we fol

lowed a consistent theme. As our understanding developed, we

began to notice a correspondence between the disciplines im

posed on traders by the market and the notions we derived by

studying the bell curve and its expression in Market Profile. At first these were subconscious revelations that led us to choose

good data representations; later, as theory and practice began to

merge, we were able to objectify our intuitive understanding.

Along the way to our final results, we had several important

contributory insights, which we'll discuss as we follow the path

of Market Profile. For example, the material on liquidity and its

relationship to randomness has very practical applications in trad

ing. The strategies of big traders are always interesting and note

worthy, and provide us a viewpoint that should in principle be

adopted by all traders. We' ll look at the concept of background,

which substitutes for financial controls for large traders, and how

it should be used by small traders. As we consider the notions of horizontal and vertical market

phases, we' ll introduce the terms dominance (the force that drives

the vertical phase) and lull (the pause that usually follows a ver

tical move, and is hard to handle). These terms will allow us to

formalize and discuss important phenomena that people usually take for granted as a background, without consciously studying

and measuring them. In particular, we' ll investigate the essen

tially two-dimensional nature of the market. The purpose of this book is to enhance your market under

standing. Your future success is your responsibility; there is no

automatic, "foolproof' formula. As you develop yourself as a

trader, take particular note of the lessons of principle-those that have come from the market itself, and those coming from your

own experiences. These will provide the basis of integrating

market data into your own trading program.

CHAPTER Two

Getting Started

In the course of this book we're going to examine the under

lying ideas behind Market Profile, as it was when we first for

malized it, as we developed it, and in its present form as we bring

it to a final phase of understanding. Unlike most books about

trading or the markets, we are not going to prescribe a specific

trading plan, nor will we give "how to" details. This book is like a cookbook that explains the principles of cooking, rather than

giving specific recipes. One always needs a deeper understand

ing than recipes or formulas can give to achieve anything real. It's my hope that this book will provide the reader with a strong

background and understanding of markets, and stimulate the desire to take advantage of the opportunity thus presented to pursue

the issue of markets further.

I have been trading for over 35 years . From the beginning of

my trading career, I have organized data around the bell curve,

loosely at first, and more formally from the early 1 980's on. I feel that I 've finally come to a full and complete understanding

of the merits and subtleties of this approach. Data organization

is fundamental to my theory of the market, and it can also serve as a knowledge base for you, whether you plan to trade as a career or just want to understand trading as part of your financial education.

7

8 CHAPTER Two

Like most of you, when I started trading I had questions relating to my ability to understand what I was going to do. How would I know whether to buy or sell? How would I recognize an

opportunity, and how long would it remain an opportunity? There

were three stages in my development as a trader. The first was an

exploratory, or educational, phase. I became interested in trad

ing while at V.c. Berkeley, after reading an article about it in

Fortune. I began to focus on trading as a career after a course on

investments. The text in that course, Graham and Dodd's Secu

rity Analysis, explored fundamental analysis. The methods de

scribed in the book appeared logical and made a lot of sense to

me. The book emphasized that mistakes or good decisions could

be isolated and understood against a background of principles.

This was my first exposure to financial controls, the use of ob

jective parameters like profits per share, cash flow, etc. to control

investment decisions. Significantly, these controls were internal,

in that they emanated from the company itself.

I also became aware that there was a profound difference between speculation and investing, and that because so little was

understood about markets and speculation, almost all commodity traders ended up losing. I read extensively in "How-To" books,

books about great stock traders, and whatever else I could find

that related to the markets, trying to find the best way to get started.

I asked myself what I was going to bring to the table. What was it

that was going to put me into the successful group? There wasn't

much material available on winning commodities traders, and,

with my lack of experience, I wasn't in a position to readily ac

cept or reject the available knowledge and teachings that were basic to the trading industry.

I decided to try to use as my guidelines the business principles

of other industries, ones where most participants were generally

successful, and see if they couldn't be applied to trading. I realize now that I was fortunate that information about winning trad

ers was so sparse, since I might have tried to emulate them and

would not have had the ability, at that stage of my development,

GEITING STARTED 9

to do so. Even at the time I felt that by studying business principles that worked I would be able to carry on within myself at

whatever level of ability I had, rather than asking myself to be

greater than I was.

Another source of potential wisdom was the many "sayings"

about trading that were passed along by experienced traders. A

"saying" is a truism coming from the practical experience of those

who have dealt with the market. For example, "The market takes

no prisoners," means that there is no middle ground between be

ing right and being wrong. Such sayings were never explained, and were usually quite general and unspecific, but they repre

sented insights that had helped people trade well over a period

time.

Both the business principles and the sayings turned out to be

fruitful areas and worth exploring further. They contrasted di

rectly with the "take it on faith" attitude and lack of real under

standing I found in most books on trading. In many of these

books, everything seemed to revolve around financial manage

ment-that you could always pre-determine where to get out,

but could not determine anything else. You took whatever came

first: if your goal was hit, you had a profit; if your stop was hit,

you had a loss. Further, with no particular knowledge or skills,

one was supposed to be able to deftly mange a winning trade to

its maximum potential. It seemed to me that this type of program

did indeed make commodity trading a gamble, just as most con

servative investment books said it was. Most commodity indus

try approaches seemed to fly in the face of commonsense business practices that were applied every day in other industries.

You would not dream of running a business you understood with

the practices these books recommended.

Most of the academic works I encountered dealt with economics or investments, not with trading, but I nevertheless found a lot of principles to think about. My basic conclusion was that

understanding had to be the key to success, and that understand

ing was a present tense process. Predictions, especially those

10 CHAPTER Two

that can be characterized as more or less baseless assumptions, cannot be used as a continual foundation for a business. In trading, people think that they can use money management to com

pensate for any assumptions they make. This is an illusion. You solve the problem by understanding the background, projecting

forward from a sound base, and seeing a contrast to the present,

not by looking at the excitement of the moment. Predictions are

dreams, and dreams are hard to evaluate.

Reading gave me a certain amount of preparation, but I real

ized that the only way to really find out anything about trading

was to give it a try. Some experience would help clarify matters

and perhaps give me a path to follow. I was not very successful

at first, but I managed never to lose more than I had. In retro

spect, this is about adequate as far as financial controls are con

cerned, as I always managed to stay about where I started. Most

of the disappointments came when things were going well and

then turned against me. After a couple of years, I started to get

the feeling that I could in fact succeed, and decided to go to Chicago. This began the second stage of my development as a trader,

what I call the early experience phase.

When I started in Chicago, I knew that I had to have a reason

to make a trade other than some baseless prediction, and a mar

ket-derived reason to exit outside of a simple profit or loss. As a CBOT member, and a floor trader, I was able to learn by watch

ing markets and traders at work. Being able to study and contrast successful and unsuccessful traders was very instructive. There

was definitely a base of successful knowledge on the floor, and

an invaluable opportunity to watch great traders in action. (This , by the way, is a problem for the young exchanges today, and for

screen-based exchanges, where there's no opportunity for begin

ning traders to learn by example.) Along with watching traders, I learned to look for market behaviors: the activity level, tone, and

so on, of markets that were moving up, down, or sideways. I could tell the basic opportunity level by how many traders were

in the pit. I would ask myself why there were 1 00 people trading

GETIING STARTED 11

com, compared to 300 in the bean pit, and how that affected the

way the market was acting. This gave me a chance to understand the different types of market activity.

In my first week of being a CBOT member, I had two real

insights that tested my resolve. Many of the successful traders at

the exchange were scalpers or scalper-spreaders, trying to buy

the bid or sell the offer. The way they illustrated their technique

to young traders was to mark a price on one side of a trading card

with a pencil, showing a hypothetical buy at, say, $ 1 .23 1/8. Then

they would flip the card to the other side, where there would be

three potential exit prices: $ 1 .23 1/4 (a profit), $ 1 23 1/8 (scratch),

or $ 1 .23 (a loss), whichever came first. They were most helpful

to me and other young members . Their advice was never to be smarter than the market. The market was always right, i .e., take

your loss if price went against you.

I understood the principle that trader discipline was important, but I felt that this type of trading again reduced the market

to a gamble in terms of whatever event came first, and I ques

tioned its merits. I did not understand the reasoning as it related to taking the loss in the prescribed manner. How could a finan

cial loss by itself make you right or wrong? I did not think that anyone could be so good as to never have an equity loss at some

time during a trade, so I decided not to use that as a determinant.

My first need was to find a way other than stops to exit a bad trade. I reasoned that the market had only three ways to move:

up, down, or sideways. I figured that if I thought the market was going to go up, and it didn't, it should at least move sideways.

This gave me a 66% chance of not losing, a big improvement

over the 50/50 chance associated with using a financial stop. If I

thought the market was moving opposite the way I was set, I

would get out immediately, but if the market was moving sideways I would tend to stay in, even if it was going against me to some extent. In addition, I was not at all skilled at or desirous of

competing for the scalping type of trades in the pits, and viewed

giving up the edge for the right to the idea as a sound practice for

12 CHAPTER Two

me. In other words, if I thought grains were going up, I would

pay the seller's price, go for the idea, and either sink or swim on the results.

My second insight came after a lunch with two respected trad

ers who had more of a non-scalp mentality, and whose trading

style was more in line with what I was doing. Both were very

interested in helping young traders from a personal as well as a

market perspective. At the end of the lunch, markets were dis

cussed. My views and trade positions were opposite theirs in terms

of the next probable moves in the markets . This was quite upset

ting to me because when I put my trades on I really felt that I was right. That night I decided just to cover the positions in the morn

ing and chalk it up to experience-I clearly had a lot more to

learn. The next morning when I got to the trading floor I decided

to wait for an hour or so and give the market a chance to go my way instead of immediately covering on the opening. The mar

ket moved sharply my way, and later that day both members came

over separately to ask what I thought now! This experience en

couraged me to keep the general principle of what I was doing in

place, and confirmed my notion that the best idea for me would always be my own: a principle I think holds true for all traders.

This attitude was reinforced a couple of years later. I was short

com over the April Stocks and All Positions report. I was fairly

bearish on the market, and it was close to the typical seasonal

end of the price movement for old crop com. Thinking that there

would be no surprises, I did not stay for the release of the report,

but instead went to a Cubs game that afternoon. Some other trad

ers came out to the game later and told me the report was extremely bullish. I felt that this was big trouble for me, and that

the market was likely to go limit up the next day. I was just hop

ing it would not start there.

I went down to the floor early the next morning and ran into a couple of large com brokers . I asked them what they thought of the report, and they said the market would likely be unchanged, or at most only a little bit higher. I was immediately relieved, and

GETTING STARTED 13

my anxiety started to dissipate. But, after a little more thought, I realized that what they had said could not be right. I felt that they

and their customers were all short, and that they were trying to talk the market down. The more I thought about it, the more I

knew that my feeling was right. The market opened reasonably

well versus my worst expectations, but well above the general

opening call given by the pit brokers, and I covered aggressively

right on the open. I was hoping that they had decided to wait and

see, and that they would be covering later in the day if they needed

to. The market closed very strong that day.

To develop myself further as I gained experience trading, I

started a program of working with what I now call market disci

pline. I studied all my trades each day against the backdrop of

what took place in the market-what I did, why I did it, why was

I right or wrong. I began to look at the market in two phases : a

background phase, and a foreground phase. Market discipline

consisted of studying the relationship between background and

foreground: the internal contrast of the market within itself

Market discipline has many connotations. Practically speak

ing, it's the school of hard knocks. It means that the market will

punish those who try to fight it. In this sense, it's a discipline that

the market can and does impose on its participants. You learn by

doing, by asking questions of yourself, by not repeating your mistakes, by taking responsibility for your actions and not com

plaining about what-ifs, what went wrong, etc. You are in a continual learning mode. The problem with using financial controls

is that background is never given any consideration-it is always

taken care of by the financial control. This prevents people who

use financial controls from learning. Market discipline is not a

well-wrapped pretty package; learning from one's experience is

never a neat and tidy process, but it is essential. In a more elevated and reflective sense, market discipline is

the market's efficiency. After all, according to academic theory,

efficiency is the reason one is supposed not to be able to make money trading. As a trader you are trading an inefficiency or a

14 CHAPTER Two

potential inefficiency that the market is trying to rectify: in concrete terms, a vertical move or potential vertical move. Usually a

trader has paid a premium in terms of trade location for the infor

mation that an inefficiency exists. The important thing to note is that an episode of inefficiency has a life and is not static. It is this

"life" that gives the trader an opportunity to succeed. The reason

inefficiency can develop is due to market uncertainty, which al

lows it to expand or contract on itself. In retrospect, it should

have been obvious to me and others that no static theory could

account for an uncertain process. Inefficiency is the ultimate con

trast of the market within itself, because that is when the fore

ground is most different from the background. Both background

and foreground must be expressed in terms of efficiency, in order

to evaluate opportunity. (For example,inefficiencies are gener

ally absorbed into an efficient background, if they are not power

ful enough to change the background.) It makes sense, then, that to succeed, one must understand efficiency, or market discipline,

work with it, and make it central to one's trading approach. As we shall see, efficiency is a dynamic phenomenon that is totally

internal to the market.

This brings me to the third stage of my development as a trader, a stage I have been in for a very long time now. It is one of

continual exposure to and absorption of market discipline, ac

companied by a constant desire to improve myself. Market dis

cipline is not a road map, it's a compass. You find the direction

and keep going, in a process of discovery.

There are two major advantages that I have had over others in trying to pursue education as it relates to markets. The first was

being on the floor and getting exposure to a lot of good traders. I

met new young traders who approached the markets in a fresh

way; in growth situations, the new are always closer to the beat, so to speak. I also met many fine traders who were satisfied trying to stay the same, and over time I realized that was not the way to go, as those who continued to update seemed to do better. Evolution theory tells us that the most specialized organism is

GETTING STARTED 15

the most successful in a constant environment, but can't survive through a change. The trader who keeps learning might not be

the most successful in any given situation, but can keep going

and adapting as conditions change. But in either case, the knowl

edge of markets as expressed by these various individuals was in

a subjective code. Hardly a trader could explain the what or the

why, but the knowledge itself was definitely there.

Most floor traders learn their skills through their experience

of the practical side of trading, where participants are brought

together in the discovery process, whether it's the open outcry

methodology, specialist, screen based, or something else. Oddly,

nothing has ever been directly written about this. Most people

who are learning to trade fantasize about being just like so and

so, the great trader. If you have the opportunity to discuss trading

with a successful trader, try to elicit the principle behind what is

being done. Remember, if someone is good over a period of time,

there is something being done right.

I was trading in the bean pit once on an extremely volatile

day, and I had bought some beans at 786. The market moved up

to around 792. Then, it paused and backed up to the 790 1 12

level. All this was taking place quickly, over a period of just a

few minutes. In the pit there were probably 40 to 50 participat

ing scalpers and traders in addition to all the brokers. Most of

them were very actively bidding, offering, and competing for any

order that carne into the pit. When the price reached the 790 area,

I decided that I 'd like to hit the next bid that carne into the market, and I didn't mind hitting a local who was bidding the bid

price or slightly under. As I watched for my chance, to my amazement not one local had both hands up and they all were only

bidding verbally, which meant that they were only required to take one contract. I sensed that my of knowledge of this situation

was not isolated, as the behavior of the whole group indicated

that they had read the market the same way, and they were all waiting to hit the next bid. I dumped the market a cent and a half

lower; it bounced back about a 1 12 cent and then broke 1 0 cents.

16 CHAPTER Two

The thing that surprised me was that we all came from different approaches, and we all traded differently, but we all knew that the situation was not favorable for an active bid.

In looking back on this experience over the years, I learned to

make the same trade over and over again. The important clue

that we all picked up on in the pit was that there was a very quick

move from 92 back to 90. This indicated a large degree of ineffi

ciency in the market, which became an outer boundary from which

the market was going to move vertically. In later years, when

ever the market was in a position where it was ending a vertical

movement that I wanted to trade against, I always waited for a

quick vertical move in the direction I was looking to go in before

I would make the trade.

This example illustrates that the market does in fact commu

nicate with those attuned to some sort of market discipline. Trad

ing based on events like quick moves, totally dead markets, and so on represents implicit knowledge that has never gotten out.

Most people approaching markets want rigid definitions, when

in fact it's best to have a general principle defined in relative

terms. The intuitive feeling of those attuned to market discipline

is filled with relativity. What is the underlying order in the seemingly chaotic open

outcry system that allows it to work so well? What information

is produced, when and how does it become available to partici

pants or to those wanting to participate, and how do they use it?

This would, if understood, be the basis from which to go for

ward, because it provides an organic understanding. It is an in

tuitive part of successful trading that has never been articulated.

Importantly, one could note that with prediction and financial controls dominating traders' thought processes, there was probably no demand for it.

The second advantage I had in coming to grips with the order

of the market was the visual output of Market Profile. I could

begin to trace the outline of market discipline in the data units of the aggregated profiles. I was also able to separate my trading

GEITING STARTED 17

results from my efforts to attain a higher plane of knowledge. Over a very long time, I was able to correlate more and more of

my practical trading experience with the visual order created by the profile, thereby getting what I would now describe as a con

vergence of the two. Each small piece of understanding contrib

uted greatly to unlocking the next problem, until now I feel that

I 've gone as far as I can, that I 've reached my goal of objectify

ing the market. This goal is different from most people's ; it's not

a trade parameter we ' re running through a database and

backtesting with financial controls to see if it produces a profit or

loss. Instead, we have built a framework from which questions

can be asked and the whole spectrum of opportunities can be

identified and routed to the proper trading programs.

For example, a friend called me last week and pointed out a

trade setup. It was good, but the trade took a lot of skill in execu

tion in terms of finding it, getting it on, and managing it. In look

ing at the background in which the trade opportunity had devel

oped, there were many opportunities earlier in the week in which

the same trade could have been made under less demanding circumstances. Most experienced traders will tell you that the set

ups for good or losing trades look identical when looked at in the

context of short-term market activity. It's the longer-term back

ground that can distinguish between them and allow a market

oriented approach to replace reliance on good financial manage

ment. Most associate not having financial controls with total reck

lessness and lack of discipline. An objectified data base, which

provides information related to the background, gives much bet

ter control than any financial control. Upgraded opportunities are

the result. While I feel that I 've reached my goal of objective market

understanding, I do not think that all my ways of implementing my insights are by any means ideal. But the basic fundamental principles are there and will not change. It is these principles

that will propel the industry forward as better ways to implement are continually found. I see basic industry growth coming from

18 CHAPTER Two

expansion into other arenas. I think that commodity trading will expand into the area of investments, and that stock investment

will expand into stock trading. Logic and reasoning in the present

tense, something we're all capable of, will begin to replace the

fantasy and fiction of predicting the future. The result will be a business that operates on the basis of internal controls, the key

ingredient for a successful business in the long term.

I have always looked to the future and tried to place myself

somewhere in it. And I think your interest in this book signifies

that you do the same. What does the future hold? I am certain

that it is going to be something very different. I really do not

have the ability to stray too far from my base, so I 'm going to just

look at the areas that I 'm currently involved in. Coming from a

ranching/farming background, I have always been resource oriented. Trading has been natural extension of that interest. From

a historic view of economics, we've had an abnormal situation in

recent years where political and economic policy has been run to

favor the financial markets-and they have certainly benefited.

In addition, there have been other fundamental changes in the

economies of the world that are supporting increasing market use. I feel that there is going to be a more obligatory participa

tion in the future; markets are going to be needed as never be

fore. And these circumstances will arrive sooner rather than later.

We're all concerned about our future as we move toward a

global society. The increasing speed of computer productivity is

running at a far greater pace than human productivity. If com

puters and our skills move along at the same rate, we' ll be needed as people. Thus, the emphasis by the government on education.

But the trend over the last four to five years is disturbing. Technology is leaping ahead at a tremendous rate. For example, medi

cal technology has gone to a level that we really can't even af

ford. We haven't kept pace, and have been left behind as a society. If we take a look at computer productivity and the growth of processing power, we're finding that the gap is beginning to widen.

Is there a path that we can get on now that assures that we have a

GETTING STARTED 19

future? This is a question that all of us should be asking ourselves. I 've come to the conclusion that trading offers a tremen

dous opportunity far beyond anything else in today's environ

ment, in that it gives a person the self reliance that seems to be

called for in the new environment. It's a skill that if learned and

mastered will take you a long way.

Another reason trading is important is because of the increas

ing importance of resource production and distribution. As edu

cation and capital spread throughout the world, we're going to

find that consumption becomes more decentralized, increasing

the economic base of markets, and this will produce a lot of mar

ket growth. I think we' ll come to a day in the U.S . , if we do not

grow at a faster pace, when other economic areas will bid re

sources away from us. This will be a drastic change. I 'm going

to stay as close to my base of expertise as possible, because ac

tivity is going to be high, and there are going to be lots of oppor

tunities for people who understand markets and trading to ex

ploit.

I ' ll close this chapter with a "saying" whose truth we've all

experienced: if you really need a break, or something favorable

to happen, it won't. Being in a position of indifference in rela

tion to luck is far better, because then you'll probably get it. Prepa

ration and skill are the foundation for a solid program for your

self. A personal "business plan" in which you prepare to take

care of yourself will never let you down.

20 CHAPTER Two

CHAPTER THREE

Market Discipline, Background, and Efficiency

The three topics listed in the chapter title, market discipline,

background, and efficiency, are the most important and least un

derstood concepts in the trading community. We've all had some

exposure to the idea of efficiency, but we' ve been conditioned to

think of it as the Achilles' heel of our trading, when in fact a

proper understanding of it is the key to unlocking the mystery of the markets. Background has always been present by default;

we're going to talk about how it changes and how monitoring

background is one of the most important factors in trading decisions. Market discipline was introduced in the previous chapter;

here we' ll expand on the idea and show its close relationship to

the other two.

The major point of this chapter, and indeed of this book, is the

central role that efficiency plays in the market. The market is a

self-organizing system that brings flare-ups of inefficiency back to efficiency. From a practical standpoint, efficiency is the mar

ket discipline that ultimately determines either a profit or loss on

your trade. The benefit from working with market discipline is that you

get closer to the market, to the point where you're really in tune

with it. Market discipline provides a basis of market study that leads you in the right direction and allows you to learn from your mistakes. The idea of market discipline is probably vaguely fa-

21

22 CHAPTER THREE

miliar to you from our discussion so far; it will be central to helping you understand the purpose of the market. The goal of this chapter is to explain in detail what market discipline is and how to use it.

I 've been working for many years to understand the workings

of the market. The benefit to me was twofold: better trading, even

though I did not have a complete understanding for a long time,

and the fact that I can now begin to objectify my data base. You

will see that understanding did not just present itself, but took

considerable time, effort, and a willingness to rely on my own

judgments, which were many times wrong. To get the most ben

efit from these ideas, you will also have to take time and effort,

and be willing to develop yourself through learning from your

mistakes.

I was very fortunate to begin to recognize the internal con

trols of the market, or market discipline, from the outset. Because market discipline is internal to the market, versus other

controls which are external, it offers an immediacy in response

time-it is always there first. If one deals with market discipline

successfully, it pushes back the need to depend on external disci

plines or controls.

Being internal to the market, market discipline is imposed upon everyone who interacts with the market whether they like it or

not; in fact, whether they know it or not. There are two other

types of controls being focused upon by people in the industry,

but they are external controls, and not really necessary if market

discipline is understood.

The most important of these external controls is what I call

trader discipline: a focus on emotional control as it relates to negative ( or positive) events in the market. It is a tough discipline, as

people tend to trade themselves versus the market. That, in my

opinion, is the wrong focus. Every trader needs this type of discipline, but I 've found through the years that it was best for me to be very active, and that the activity tended to push me through any areas relating to emotional control. Shortly after my second

MARKET DISCIPLINE, BACKGROUND, AND EFFICIENCY 23

year of trading, I realized what some of my many character flaws

were, and I decided to rectify them, so I could improve my trad

ing results. After six months of hard work I had made absolutely

no progress (and not much more money, either). I then decided to

accept my faults and neutralize them by working with situations

where they did not come into play. By featuring the things I could

do well, and accepting my shortcomings, I had exponential gains.

I call this industrial indifference: feature what you do best and be

aggressive.

The other discipline is the financial one that has engulfed the

industry: the emphasis on money management. The very fact

that it is endorsed by all segments of the industry (including le

gal , regulatory, management, and the printed literature) means

that it should not be a trader focus. It should be present to a

natural degree, and one definitely needs to be aware of it, but

anything beyond that is inappropriate. Financial discipline tends

to creep forward, engulfing more of what you do, and in general

interferes with the clear logical thinking needed to trade. It makes

managing your trades an all-foreground program, as financial

controls take the place of background. Every opportunity is treated

the same way, when in fact no two are alike. Overemphasis on

financial controls is a sign of a lack of understanding and self

confidence, and leads to a false sense of security.

The same is true in any area of business. As an example, a

young and growing business has a banking relationship at the

outset wherein the bank believes in the company and its manage

ment. The relationship often does not fit all the bank's risk poli

cies (which are their financial controls) as set out by the loan

committee. As time goes on, and the business gets on its feet, the bank becomes stricter about its rules. Making a new business

satisfy all the requirements shows little or no interest or confi

dence by the bank, and forces the management of the business to focus on satisfying the bank near-term instead of on growing the business and its industry.

24 CHAPTER THREE

As individuals, we all are different, and will not necessarily fit a particular style of trading. Market disciplines are the most

natural and immediate form of control available. It does not make

sense to focus on trader or financial controls, which are artificial

and external. I realize that some need more financial controls,

just as some need to overcome themselves. I just want to point

out that these types of problems are out there in all industries and

are external to the businesses themselves.

Working with market disciplines, or market control, does not

imply that we now have control over the markets ; they are uncer

tain. It means that we can gain control in a business sense. We

have an understanding of what we are trying to do, and we have

an understanding of what the market is doing. We can get objec

tive answers to our questions. For example, a car maker might ask, what is the condition of the car market today, and what is our

market share in the compact market? How is our new model

moving compared to last year ' s model and to our chief competitor's? Has our new advertising the past month shown

any benefit? A trader would ask, where is the soybean market

now? Has there been any change in its condition in the past week?

If so, what? What type of opportunity is it? What is the best way to trade it? How can we tell if we are right or wrong? These

types of questions need to be answered in order to be successful, and this book will provide the basis for doing so. Successful

traders have always done this subjectively, so it is not an impos

sible goal. Objectivity, which can only come from a complete

understanding of what we're doing and what we're working with,

will allow more traders to achieve the same goal. We as traders need to understand not just the workings of the

market (which is what I mainly focused on at the beginning), but

what it does, what it does it for, and how it does it; what it means to call the market a self-organizing system, and what the orga

nizing principles are. We need this foundation in order to gain a complete understanding of market discipline.


Understanding the market's purpose is the key to unlocking

all this. This basic insight eluded me for a long time. My ap

proach has always been from the ground up, trying to merge prac

tical results into theory, rather than starting with a theory and

trying to fit my observations into it. I think the fact that I made a

persistent effort was more important than any one particular idea.

It was my varied experiences in using the developing profile sys

tem that revealed the most. I could always seem to find new ap

proaches to keep the discovery process going. The constant

changes taking place in the market really brought focus to the

situation. It forced me to continually do things differently, and

finding the same answers over again in different ways brought a

degree of confidence that I was on the right path.

Let's take a look at some specifics. From my beginnings as a

trader, I have always tried to work with a consistent and recur

ring aspect of market activity. This ties the trade opportunity to

the market and to my knowledge base, and the trade potential is

therefore much easier to manage on its way to maturity. For

instance, when I first got to Chicago, the markets were very ac

tive and the pits were generally full. I had a really hard time read

ing the market activity when the pits were not full. Being more

of a position trader, I began to notice that most of my profits

would dwindle or disappear after the pit emptied out. I saw that

the pit emptied because the good traders could sense a lessening of directional activity through the order flow, and that it filled

again when there was a new opportunity. The market would al

ways go the opposite way as the pit filled back up. After a short

time I realized that I should exit my trades when the pit started to

empty out in order to hold on to my profit.

As with the last trading situation I described, I have taken

advantage of this same situation over and over again during my

35 years of trading. Obviously, my ability now after years of ex

perience to recognize the market conditions that precede the trade is the key to finding it again. The essential ingredient is the market's background, which is one of high efficiency. With this

26 CHAPTER THREE

background, any inefficiency that causes the market to move in either direction is eventually absorbed into the background of

efficiency. Also, with this background, the market tends to move

in the opposite direction from the one it had been moving in when reaching efficiency. Efficient markets are trading markets, where

the inefficiencies run out of gas before they can change the back

ground, causing the market to move in the opposite direction when

a vertical move ends.

Another experience taught me to recognize another type of

background. When I started out, I traded all the commodities that

were offered by the exchange, rather than just one. I noticed one

day when I was standing in the corn pit that there was a loud roar

coming from the soybean pit, and that runners were scurrying to

the brokers. The floor was totally focused on the attempt to move

the market higher. The price at the time was about 2.52 a bushel.

About 45 minutes later, I noticed that the price wasn't any higher

than it had been when all the activity started. It seemed to me

that all the king's horses and all the king's men could not make

the market go higher. I also thought it would be difficult for it to mount another charge of equal magnitude, and that I ought to go

over there and sell the market. And, in fact, the sale worked out

well.

Once again, this is a trade that I 've made over and over again. The issue here is that the market was at an efficient price. Gener

ally speaking, when the market is in a state of efficiency, it is going to move vertically out of it at some point due to some real

or perceived change. When the market has made a good attempt

to move vertically in one direction, and fails, going for the opposite direction is one of the easier trades to make, because prices will either move in that direction or at worst stay the same.

In today's markets, I have noted that this condition often comes about when the market is focusing on a government report. There are two possible market conditions prior to the report. In one situation, everybody is generally getting flat, and the market has reached some state of efficiency. If the report comes out and it's


deemed to be bullish, and the market barely opens higher and

then starts breaking, then it's the same situation as the bean trade all over again.

If the day before an important report that everyone's looking

forward to is an active directional day, it can make the report

redundant, because in this case the market has not reached effi

ciency prior to the report. When a report is issued in an efficient

market, the market will go one of two ways: if there's no rally on

a bullish report, it gives the other direction all the momentum. If

the market is inefficient and moving directionally prior to a re

port, generally the condition will prevail regardless of the report.

This is again illustrative of the importance of understanding the

background.

There's something in common among the trades mentioned

here and the bean trade example in the first chapter. They all

illustrate what I mean by opportunities that come internally from

the market. The ideas for the trades did not come from anything

that I had read, nor did they come from any particular study, nor

from technical analysis, nor from fundamental analysis, nor from

the person standing next to me, nor from a news letter, nor from

a news flash, nor from a squawk box that detailed what commer

cial was buying or selling. They were real trading situations that

developed from within the market, and they were recognizable

as characteristic of some type of opportunity. Right now I am

only trying to make the point that there is a great difference between internal and external approaches to trading. This in itself

is not startling news, as most traders like to have good floor sup

port from their brokers. But mere closeness to the floor does not

have any value in and of itself. The closeness must come from your own program, and that calls for your program to be aligned

closely with the workings of the market. Over the years, I have tried to take these kinds of practical

observations and translate them into theory. But in my case practical success did not translate immediately or automatically to a correct theory. In academic circles, accepted market theory had

28 CHAPTER THREE

cast the market as being statically efficient, and hence implied that traders could not succeed in that environment. (The idea be

ing that a trader succeeds by taking advantage of a situation where

price has moved away from value. If price immediately changes

to reflect value, there's no opportunity.) I had seen a great deal

of success in the markets and this focused me in the opposite

direction, away from the idea of efficient markets . I started to

look elsewhere for the answers, but progress was slow. I felt it

was necessary to understand the purpose of the market, and that

did not seem to be expressed anywhere by anyone. I spent a good

deal of time trying to find it, as you will see later on.

I mentioned earlier that one potential source of wisdom I con

sidered were the many "sayings" about the markets and trading.

These sayings tended to be very practical in application, yet al

ways seemed to defy logical explanation when I attempted to pin

down just how they worked. Looking at the market within the

context of accepted market theory and of practical sayings, it would be fair to say that the general workings of the markets

were unknown and unexplored. Supporting this claim is the fact

that even the practical everyday traders used external disciplines to control their trading-a situation that is still very much the

case today.

My insights arose in large part out of working with the Market Profile notation as it evolved over time. Many readers will be

familiar with at least the basics of Market Profile; for those who are not, let's take a quick look at it.

In its raw form, data about a market is just an unstructured

stream of numbers, recording the various times and price points

at which buying and selling takes place: the sort of information

recorded on a ticker tape. In an effort to gain a visual overview of

price activity, traders came up with the bar chart, in which a ver

tical bar records the range of prices for some fixed time interval.

Many traders use daily bar charts ; for our purposes, that time interval is too coarse. A popular intraday time interval, which

became the foundation for Market Profile, is 30 minutes.


Figure III-I. Exploded profile chart for Dec. LIFFE Bund, Nov. 6, 1996

The problem with a bar chart is that it captures only one

dimension of market activity: the vertical. Because the horizontal interval is fixed, there is no variance allowed in the display. The

profile chart is, as we shall see, much more two-dimensional, in

that it allows for horizontal variance. The easiest way to understand a profile chart is to start with

each 30 minute time period shown as a separate column, similar to a bar in a bar chart. In Figure III-I , the price data for the Dec.

LIFFE Bund for November 6, 1 996 is displayed in this fashion.

(The asterisks are inserted by the Market Profile software, and

need not concern us here.) In Market Profile, each half hour of the day is assigned its own letter. The LIFFE Bund begins trading during "1" period, so "1" is the leftmost column for November 6. The next half hour is called "m", and so on through the

alphabet; the half-hour following "z" is "A". Now we're ready to create a daily profile chart. (The result is

shown in Figure 111-2.) The starting point is "1" period; its range is from 1 00.3 1 to 1 00.40, and "l"s are placed in the correspond-

30 CHAPTER THREE

Figure 111-2. Daily profile chart for Dec. LIFFE Bund, Nov. 6, 1 996

ing rows (price levels), forming a column just like the column of

"l"s in Figure III-I . The next period is "m", which ranges from

1 00.35 to 1 00.47. Its range overlaps that of "1" period between

1 00.35 and 1 00.4 1 . When the "m"s are added to the daily profile,

the ones between 1 00.35 and 1 00.41 go to the right of the "l"s,

making the developing profile two letters wide at that point. The "m"s between 1 00.42 and 1 00.47 are the first letters in their price

range, so they go in the leftmost column, where we placed the

original "l"s. If you look at just the "l"s and "m"s in the Nov. 6

profile in Figure 111-2, you can see this pattern in place. Now we go through the rest of the half-hour periods in the

same way, assigning each letter to its proper row (price level), and to the first empty location, starting with the original "1" col

umn. The effect is as if we collapsed the half-hour columns of

Figure 111- 1 by squashing them over to the left as far as possible,

with the "1" column as a starting point. Notice the difference in the information conveyed by Figure

111- 1 and Figure 1II-2. In Figure 1II-2, the width of the profile


3 2 1 2 3

Figure 111-3. The Bell Curve

gives a clear indication of the horizontal movement of the market. If the market spends its time in a small range, the result will

be a short, wide profile, in which the horizontal aspect predomi

nates. A fast-moving, directional market will create a long, nar

row profile in which the vertical clearly predominates. (For ex

ample, periods "z" through "E" in the last profile in Figure III-2.)

This brings out the vertical dimensionality of the market, in con

trast to "1" through "y" periods on that day.

One feature of this chart deserves some comment. When we first began working with profiles, we started a new profile each

day. This had some justification, since the global, 24 hour market of today was in its infancy, and each day on the floor had a dis

tinctive beginning, middle, and end phase. As we move through

this book, developing our ideas, we' ll also show the corresponding evolution of the profile notation.

The other aspect of profiles that should be brought out at this point is their tendency to fall into a pattern resembling a bellshaped curve. The bell curve, which is at the heart of much of

32 CHAPTER THREE

statistical theory, arises in situations where we're studying a quantity whose value is influenced by a number of contributing factors over a large population. For example, if we were to measure

the height of all the men in the country, and make a bar chart of

the result, the chart would form a bell-shaped curve, since height

is influenced by a host of genetic and environmental factors. Of

ten the situation in the market is the same, as many small influ

ences on each of a multitude of traders act to form each person's

opinion of a good place to buy or sell.

Figure 111-3 shows a typical bell curve, with some of its more

important features highlighted. If we think of this curve as a bar

chart of heights (where each bar is only one pixel wide), then the

center value, the highest point on the curve, represents the single

most common height. This value is called the mode. For a bal

anced curve such as this one, it is also the mean, or average,

height. If we go to the left and right of the mean, far enough to

enclose approximately 67% of the data, this distance is called the

first standard deviation. It's shown as a dark area in the center of the bell curve in our diagram, and marked with the number " 1 ." If we go out further from the mean, far enough to enclose ap

proximately 95% of the data, we get the second standard deviation; adding the third standard deviation encompasses approxi

mately 99% of the data. In statistics, the size of the standard de

viation is used as a measure of variability; we've found it useful

in a similar vein when applied to profiles.

Look back at the profile for Nov. 6 shown in Figure 111-2. If

you tum the book on its side, so that the left column of the profile

becomes the bottom, the resemblance to a bell curve is clear.

This profile is particularly close to the classic shape, with its mode almost exactly in the middle and the volume distributed evenly

above and below the center in the characters tic shape. We'll ex

plore the implications of this resemblance, and what it means

when the market departs from it, as we develop our theory of the market.

CHAPTER FOUR

Looking for the Purpose of the Market

As I began to work with profiles and develop my theory, my

first pronouncement was that the purpose of the market was to

facilitate trade, i .e. , to try to do the most business possible. Read

ing the market from my background as a trader, I was not yet aware that trading activity within a constricted range is a sign of

efficiency, or that the fast action on the extremes of vertical moves

reveals a high degree of inefficiency. What I did notice in a prac

tical sense was that the market would not go where it could not

trade. When it tended to hold and accept an area, that area proved

not to be an extreme. If the market was moving directionally,

then I would assess the amount of activity as being increasing or

decreasing; if it was increasing, I 'd stay in or go with it, if de

creasing, I would get out or go against it.

The important point is that I was using information coming

from the market. But, although the theory of trade facilitation

was useful in practice, it was a long way from capturing the pur

pose of the market. Looking back, this theory was more descrip

tive than analytical in nature, but it did succeed in giving a good reading on continuation of directional change.

As time went on, I refined the concept of vertical movement as it relates to trade facilitation to declare that the purpose of the market was to distribute. This was the channeling of trade facilitation (capital flow) into a medium of expression (markets). Ac-

34 CHAPTER FOUR

tually, this was farther from the true purpose of the market than my original theory, in that distribution (a one-dimensional verti

cal move that stands out from the background) is an expression

of the degree of inefficiency. What was revealing was that distri

bution was part of a sequence of events : prior to a vertical distri

bution the market had to have a base of horizontalness in order

for the distribution to be seen. In other words, an underlying order of events was there which could be recognized and so po

tentially lead to some form of control.

Moving from trade facilitation to distribution as the underlying purpose of the market advanced our understanding by pin

pointing the area where the distribution started. I noticed that the

background prior to the start of a distribution was always more

horizontal, and this led to the key insight of a two-phased mar

ket. Also, in the early days a vertical move usually started in the

fat, or horizontal, part of the day profile. In short, the distribu

tion theory advanced the necessary understanding of vertical

movement for practical use, but it did not truly identify the purpose of the market.

Throughout my early career, I wrestled with the issue of

whether or not the market was efficient. From a practical stand

point, I did not think it was efficient, or if it was, it was only

efficient for short periods of time; it was not statically efficient.

Further, in my trading, I was not interested in the phase when the market was more horizontal, and thus potentially efficient. I started

to take notice, however, when evidence showed that a lack of

activity, which created a horizontal profile, usually preceded a

good vertical move.

What really brought this phenomenon into focus was the num

ber of misplayed opportunities that started with a horizontal market. It has always been a good trading practice to go with some

thing until it's no longer there, and not to trade for what isn't

there. I mostly adhered to this practice, and, as a result, I would sometimes be fooled by what I called a false expectations gap.

Nothing at all would be going on, so expectations vis-a-vis the

LOOKING FOR THE PURPOSE OF THE MARKET 35

day would be extremely low. This condition would usually have

persisted for a week or so, to the point where I was concerned

about my ability to find any well-paying opportunity. Most of

the things I did would just sort of die on the vine. At this point,

more often than not, I would start off the day trading what I thought

was a good opportunity. The market would immediately go my

way, and I would quickly get out, having been conditioned to do

so by the quiet market. It would never fail that the market made

my small expectations look foolish.

At this point, I was totally unaware that efficiency was the

set-up for change. From a practical viewpoint, market efficiency

was not in the vertical price action, which is what I was looking

for, but in the horizontal, offering very little opportunity for trad

ing profit. I tended to avoid horizontal price action as dull, a market

with nothing going on, and tried not to trade under those condi

tions. As time went on, the fact that the market had what ap

peared to be two phases, dead and then vertical, began to register

in a theoretical way. I began to reassess my earlier rejection of

the generally accepted theory of efficiency, as it seemed that I

had recognized efficiency in my practical trading. It was defi

nitely a market condition, but not a constant one. The market

was not statically efficient, so its other phase had to be non-effi

ciency. The market appeared to spend most of its time being

non-efficient (vertical), and shorter amounts of time being effi

cient (horizontal). The efficient periods were the most difficult

to trade.

It took a longer time to notice that the market was always trying to get to efficiency; that efficiency, in fact, was always

present in the market to some degree-and, conversely, that the inefficiencies also were never entirely absent. The varying ratio of these two factors is what makes the market dynamic. Being

dynamic means that the market is always somewhere between

99% efficient and 99% inefficient. And, most importantly, trying

to get to efficiency is the market's goal or purpose. This whole

36 CHAPTER FOUR

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Figure IV-I. 30-year Bond futures for late June and early July, 1 996

fundamental concept can be summarized in two words as dynamic

efficiency.

To illustrate the market's process of moving from inefficiency

to efficiency, consider the chart in Figure IV-I , which shows 30-

year Bond futures for early July, 1 996. In this example, we can

follow the life cycle of an inefficiency, and see how it eventually

gets snuffed out by horizontal activity, preparing the way for a

new inefficiency to happen. The second profile from the left, for

June 28, shows inefficiency predominating, as the market made

a strong vertical move. The market then begins to trade more or less sideways. We refer to the fat part of a profile, where most of

the volume is concentrated, as the first standard deviation. Looking at the profiles for the 28th and 30th, the first standard devia

tions are in the upper part of the daily range, while on the 2nd

and 3rd they are at the bottom. It appears, then, that the life of the

inefficiency has been taken out by the consistent average activity of these four days. In viewing the background, you can see a

change, and a completion, so you know that whether you have a

LOOKING FOR THE PURPOSE OF THE MARKET 37

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Figure IV-2. Bond futures profile showing market development

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profit or loss in the trade, the life of the inefficiency that caused

the market to move is over. On July 5, the next cycle began with

a sharp decline.

Another way to look at the process is to reorganize the pro

files, getting away from using chronological time beyond the day

timeframe. The idea is to start a new profile when the market

shifts into inefficiency, i .e . , distributing, and to combine all the

half-hour periods as the market works its way to efficiency. In

this way a roughly bell-shaped profile should emerge from the mass of data, culminating with a new vertical move. Figure IV-2

shows the profiles from the chart above regrouped according to

this scheme. I knew that discovering the market's purpose was the key to

objectivity. I had been trying to find it for many years through

my work with Market Profile. Many people would assume that the highest possible goal of data arrangement would be a trading system in which money would come out forever. I do not believe

that such a system is possible or even necessarily the best thing.

38 CHAPTER FOUR

•

Having a trading system as your goal would mean working for a limited purpose. A deep understanding of the market's dynamic

functionality leads to control over your interaction with it. Build

ing an objective data base where any question can be asked or

answered is far superior to having a set of trading rules.

On realizing that the purpose of the market was to move to

wards efficiency, I felt that most of what I had done prior to this

point could be understood as a subjective reading of efficiency

subjective because I had yet to gain a full and complete under

standing of the market. During the discovery process, insights

gained from working with Market Profile had begun to reveal

clues that seemed to dovetail with everyday experience. In the

early stages of Market Profile, the fact that the market was constantly trying to shift into the horizontal phase of activity was the

key ingredient in all our trade parameter classifications. Trading

experience reinforced this even further, and the ultimate conclu

sion was that the market was always to trying find efficiency

through a dynamic process.

CHAPTER FIVE

Efficiency and its Role in Market Organization

Efficiency turns out to be very important for two reasons. First,

it creates the most readable vertical reference in the market. It

generates a fair price, which is the base from which the market

can evaluate any change. Even as the market moves vertically, it

will constantly try to find efficiency, and therefore bits and pieces of horizontal development can be found throughout the vertical

movement. These represent a reference from which further verti

cal movement is evaluated by the market participants. Then, as

horizontal trading becomes more predominant, a more concen

trated appearance of efficiency becomes evident.

Second, an aperiodic cycle of activity repeats itself as the mar

ket moves itself into the future. Non-efficiency continually flares

up and is processed out again and again. The market shows a

continuous self-organizing capability that is based upon bring

ing a data mass to efficiency. Each completion leads to the next

one, as efficiency reasserts itself as a natural result of the trading process. The market processes each small episode of ineffiency

that is part of a larger move; then, when the move is complete, it

brings the entire large-scale data mass to efficiency. Efficiency represents more of a certainty, while the vertical moves are an

expression of uncertainty. The net effect is a self organizing sys

tem that is in control of market activity and only needs to be understood.

39

40 CHAPTER FIVE

Let's take a closer look at the self-organizing process inherent

in the market. The initial vertical market movement can be thought of as gathering or attracting those who want to become involved.

In this way the market begins by searching for a vertical range

from which to apply or define efficiency, and then begins to pro

cess out the accompanying inefficiency. Thus, the market's pro

cess has two distinct stages, with the vertical occurring first. The

entire process is dynamic and not necessarily easily readable; the

data mass that is brought to efficiency is always going to be ir

regular. For example, too few or too many participants may be

attracted in the initial phase. Too few leads to further gathering

(i.e., more vertical movement); too many means some need to be

processed out, producing extended horizontal or opposite verti

cal activity.

Fundamentally, one says that the market has or has not priced

out the users . Market observers in the media provide the "ex

cuses" for price moves that we're all familiar with: "profit tak

ing," some news event, a statement by an authority, and so on.

Experience has shown that where there is a directional stimulus,

and nothing happens, the opposite direction generally ensues,

showing that you already have too many participants in the mar

ket. In either situation, the market is always moving towards efficiency. The impulse towards efficiency is an unrelenting force

that is always present, always active, always trying to get con

trol. It always accomplishes some part of its goal, so, when it is

not present to any large degree, the suggestion is that the market is not done vertically. This is what allows readability-this is

what the intuitive trader picks up. For instance, most floor traders will tell you they try to make the hardest trade rather than the

easiest trade; if it's easier to sell, it's usually the wrong way to go, and vice versa.

Let's look more specifically at the market cycle. The market

first tries to establish one vertical reference point, a point that is very hard to read in the present tense, due in part to the volatile

nature of the market at this stage, with its many ups and downs.

EFFICIENCY AND ITS ROLE IN MARKET ORGANIZATION 41

Then it proceeds to find the other outer parameter, i .e. , the second vertical reference point, again hard to read in the moment.

Vertical activity is quite irregular in the data mass (volatility can

not be neatly cataloged), and the where and how of these refer

ences can't be easily established. It's only necessary to know that

they will happen. This is the gathering process, the first stage,

and is highly unstable and difficult to read.

To some extent during, but mostly after, this process, the move

to efficiency will begin to develop. The fair price area, or effi

ciency, is what I call market output, the result of the self-organiz

ing system. This represents the real "close" of the market pro

cess-that is, the result that summarizes that phase of activity. It

is necessary for the market to find this in order to start the whole

process over again.

It is important to note that the outer boundaries and the amount of data processed during this cycle will vary dramatically. It is

the output of efficiency that is the constant. The cycle from inef

ficiency to efficiency is a great reference at any stage of its development, whether the beginning , middle, or end. Like the de

veloping ears in a crop of corn, it represents a direct output that

can be measured in stages . Price discovery, long thought of in

relation to a fair price, has an entirely new meaning in this con

text: it's defined by where the market is in its process. You may have a fair price generated during the gathering phase, which

would be one of the vertical extremes, or a fair price during the horizontal phase, which would represent the consensus fair value.

Also note that in the process of gathering the market will try to involve those on the edge of development, because it's easier to

do the job once than to do it twice. This explains the volatile

nature of the market in establishing vertical reference points and the difficulty in using them.

A practical example of a gathering process similar to that of

the market comes from my personal experience. As a young man, I had to gather cattle every year on the family ranch after school was out at the end of May. The first thing I did was ride my horse

42 CHAPTER FIVE

to the outer reaches of the ranch boundaries, trying to push the

outlying cows and calves closer to the middle of the ranch. If some of the cattle were on the adjoining ranch, I 'd have to move

further out in the gathering process. While I was doing this I was

looking at the condition of the cattle. If I saw four or five cows

with only two calves, or four or five calves without cows, I knew

conditions were not perfect. This did not give me a reading on

the entire herd, only an indication, the answer to which might be

over the next hill. I 'd be getting some insights as to the overall

condition of the cattle. It would be hard to rely on this small

amount of information or make a decision based on it, but still it

could be very significant.

As we moved more towards the interior of the ranch, or to

wards the natural location of the corral, and I gathered more of

the herd, my information would become better and more reli

able. Finally, in getting the whole herd into the corral pasture, we

would definitely know what the condition of the herd was. We

could see how many cattle we had versus what we turned out,

what the cowlcalf ratio was, what the condition of the cows and

the calves was, and we could begin to make plans for next year, which would be a new cycle of development.

The market organization process is very similar to cattle gath

ering. The initial gathering at the edges of the ranch corresponds

to a dynamic vertical movement in the market, whose purpose is to draw in participants. The vertical movement is seldom purely one-dimensional; it also means the beginning of the effort to move towards efficiency. The herding of the cattle towards the middle

of the ranch reduces their range of movement, just as the market's vertical range of movement decreases as it becomes more effi

cient. The gathering of the herd in a constricted space corresponds to a more horizontal market where we can get a better reading on its condition. As we get more of the cattle gathered, from a quar

ter, to half, to three quarters, we get increasingly more reliable

information as to what the year was like, and are able to plan ahead for the next year; as the market approaches efficiency, we


have a solid reference point against which to measure future moves.

To summarize our discussion so far, efficiency plays a perva

sive role in the market when looked at dynamically, since it is

always present to some degree. Efficiency is the only market in

ternal that can be read throughout every phase of the market cycle.

In reading the degree of efficiency, you are reading the degree of

horizontalness . A reading of efficiency is the information source

for all market disciplines, as it is the basis for processing the

vertical out of the market. We've demonstrated the central role of efficiency. Now we're

going to discuss it in a bit more depth, and define a complex of

related concepts that will help us understand how efficiency af

fects the market and how it communicates itself to the trader. In the process, I ' ll be talking through some of the insights that came

from my experiences as a trader. Note that in practice both the vertical and the horizontal are

actually good trading references. If we examine the extreme ac

tivity of the market, we would conclude that near or total verticalness would be the extreme of non-efficiency, and that near or

total horizontalness would be the other extreme of efficiency.

Since they both represent the outer reaches of the market, these

extreme conditions signify beginnings, and one should be alert

for that. Being dynamic, the market tends to vacillate between these two conditions. Neither the vertical nor the horizontal ever

disappears, but one or the other is the dominant element in the

market at any given time.

Market condition could logically be expressed in either di

mension alone, or in both. The form we choose can be whatever is most convenient for a given study. We must note, however, that one would want the expression of market condition not only

to be a meaningful and usable communication, but to offer the possibility of optimal control of trading as it relates to measurement. When the market is moving horizontally in a small range,

that is, when it is highly efficient, the penalty for a wrong deci-

44 CHAPTER FrVE

sion on direction is small. When the market is in the midst of a volatile vertical move, then the potential for damage from a wrong

decision is much larger. Therefore, we' re more interested in study

ing the horizontal, and expressing the market's condition in terms

of it. I have always approached control by first establishing the outer

boundaries of possibility; control then has to be within them.

Consider a market that is highly horizontal versus one that is

vertical. In the first instance, both boundaries have been estab

lished through time in a small range; in the second, it's much

harder to establish a usable constraint. The dimension of non

efficiency is extremely hard to confine, since it is not bounded in

the present tense. It is very unstable and does not lend itself to

internal measurement. Its composition is not that of consensus

but that of aberration. It's very abrupt, and forces exposed trad

ers to react. Each vertical move is unlike any other; therefore, the

change towards efficiency is extremely hard to perceive, and is

not of much value as a base indicator. It is safer to use the hori

zontal: efficiency, being accepted as consensus over time, has

the very characteristics that lend themselves to accurate and mean

ingful reading of changing market conditions.

Rather than being the impediment to trader success, efficiency

is the very reason traders can make money. It's what a trader

intuits is lacking in the market and thus takes advantage of. While

it's there, it provides a basis from which to sense and evaluate the degree of change.

This points up the need to incorporate the concept of change being relative rather than absolute. Traders' expressions of the

market being tight, tired, heavy, etc. are based upon reference to

the horizontal state of the market. Change is related to efficiency

in principle, and the traders' expressions are degrees of interpretation. In understanding the market as dynamic, one needs to think not of bringing a single inefficiency to zero or removing it from

the market, as is the current tendency; rather one needs to think

of reducing its degree of influence as it relates to a total base,


which is made up of a varying degree of both horizontal and vertical influences. To attempt to measure volatility is technically incorrect; one should be looking at the degree of efficiency.

Volatility is vertical and hard to measure except by measuring it

at the changing outer limits. In a volatile period the increment of

change is coming from the outside into the market rather than

from the inside out. More accuracy and better trading would come

from measuring efficiency.

Liquidity is classically thought of as indicative of the depth of a market. Its real value is informational to market participants.

Liquidity is a form of counter-directional control in a market. It

is a horizontal functionality, a platform that increases the already

horizontal nature of a market, or decreases the vertical nature. For most traders, liquidity represents a method of reading the

degree of efficiency in the market. Liquidity changes as markets

move from the vertical, towards the horizontal, and into the effi

cient zone of development, so liquidity does in fact reflect effi

ciency. Unfortunately, it is not a constant force, and can and

does move within itself, making it a difficult read at times.

Randomness and liquidity are really one and the same. Ran

domness means that the preceding order has no relation to the

following order. Randomness is in effect, then, when nothing is

really going on. Liquidity is a force that is an extension of ran

domness. Liquidity expands the boundary of randomness by al

lowing successive directional orders to be neutralized. Locals who

make a market have in the past received an edge, and should

retain the edge if the market stays in the random zone. The more

liquidity, the stronger the bounds of randomness, and the harder

it is for non-randomness (directionality) to emerge. This relates

our notion of liquidity to the classical one of depth in the market.

Non-randomness is the start of something directional (vertical) and the shift of control to new forces. The stronger the liquidity,

then, the more reliable a change is when it does occur. Liquidity can be confined to a certain zone or portion of the

market's range. This type of liquidity in the market may create

46 CHAPTER FIVE

choppiness and a more vertical horizontalness in which the market has ups and downs instead of just stopping at a particular

vertical reference point. Another type of liquidity comes into play as the market moves directionally, opposing the market every

tick of the way. A third way in which liquidity enters the market

is when prices go to truly unusual extremes, so that they then

become references for participants to trade against.

As liquidity lessens, you lose the readability of the market

because it becomes more volatile in a random way. Liquidity can

no longer be used to gauge efficiency. In other words, a highly

liquid market can also be thought of as highly efficient, but an

illiquid market is not necessarily inefficient. There was formerly

a link created by the floor trader who helped provide liquidity

and who was reading efficiency. Indirectly, all this is expressed

by your fill and by the fast market indicator you get on your screen.

Most traders would agree that when they get a bad fill the

chances of winning on a trade are higher than when they get a good fill. I had a good example of this many years ago, when I

shifted to be more of a go-with trader. Com was called a couple of cents lower and I decided to sell the opening. I put my order in

and the market opened close to and limit down, and quickly

bounced several cents off this base. Naturally I was filled at the

limit. If I had known it was going to be limit down, I definitely

would not have sold it. I now was in a position I surely did not

want to be in, and one that I could not do much about. I still felt

that I was right, but I was very uncomfortable. But I was with the

direction of the market, and several days later had a nice profit.

This corresponds to the floor trader who always notices that the

easiest trade to make is the wrong one: if it's easy to sell, it means

there are lots of buy orders coming in, so selling is a bad idea.

I have learned a great deal about trading from the largest or most dominant trader in the pit or arena, from the type of activity that really represents control of the market for that moment. The

market is not random in these circumstances, but has a known

dominance, where dominance is defined as a directional force


that exceeds liquidity and is the start of something. The big trader

in this case is the source of dominance, and is really controlling the foreground with his activity. The fact that the directional im

pulse exceeds liquidity means that the background needs to be

favorable, in order for the trader to retain control. In order to exit

a bad trade with a small loss rather than a large one, the big trader

cannot be totally wrong about the background. Regardless of profit

or loss, it's always the background one has to exit to.

As an aside, to begin to focus on background, which is all

important in trading even for those who would like to use finan

cial controls, it's a good exercise to assume that your trade repre

sents the biggest position in the market, and to ask yourself where

you think you would land if you had to get out. With marginal

trades, you would find that you would have a big loss. This is relevant to all traders because if in fact there is little

liquidity, we have a similar situation to deal with. There are no

financial controls that can neatly take us out. Control must again

rest with either the background or foreground of the market. In

using a financial control (such as a stop) to exit, one never begins

to learn about the background. Over a long period of time, this

has a devastating effect on one's trading success.

The trading floor was a great place to learn the lessons of back

ground. For instance, one day the beans were trading about 1 5

cents above limit, and prices were on their way down-the back

ground was definitely to the down side. The market was very

volatile, and it was very close to the closing bell. The market hit

a bunch of stops in one part of the pit and brokers were offering beans limit down at the same time they were still trading 1 5 cents

higher in other parts of the pit. (All this took place in less than 30 seconds.) You have a choice as a trader in this situation either to

sell the higher price first or buy the limit down. Good floor trad

ers would automatically understand that since the background

was weak, selling the buy orders was the appropriate strategy, as they were the anomaly or inefficiency. Poor floor traders would look to buy at limit and think it was a steal-but, if they could

48 CHAPTER FIVE

not get it off at higher prices, they would be caught on the balance limit down, and maybe have a big loss the next morning if the market was limit down again (which in fact it was).

This is a good example of background rather than foreground

controlling a trade. There were two opportunities that were

roughly equal on a superficial level, with the background deter

mining which one was better. In this case, the inefficiencies (the resting buy orders) were absorbed into the background because

they weren't big enough to change the background, where the

background comprises sell-at-market type orders. A point to ask

yourself right now is, how often is background the deciding fac

tor in your trade decisions? The best floor traders always took the whole offer. The ad

vantage to taking the whole offer was that when the orders came

in the other way, the trader would be in control, rather than hav

ing 1 0 or 1 5 people competing to get out. The trader took out the

competition of the background by denying inventory to every

one else. This is an example of the type of floor discipline that I learned in Chicago. I was always aware of trade opportunities

where I did or did not do well, but more aware of the lesson or

principle involved.

Dominance, as we stated earlier, is a directional force that is

non-random. When present, it is in control of the market. It does

not express itself as a constant very often (an extreme example of

which would be successive limit days), but rather intermittently.

In other words, it does not operate continuously, but has interruptions. Its appearance is not consistent; it shows up differently

all the time. What was previously a dominance may not occur

again in the same manner, or, if it does, may not have the same impact. It is variable and changing as markets change. The only markets I experienced that had a constant expression of it oc

curred in the 70's for a very short period of time. The vertical

movement was very one dimensional and persistent, to the amazement of most experienced traders, induding myself.


Normally, traders read dominance on a relative basis versus efficiency, efficiency being the standard from which change oc

curs and which it can be relatively measured against. Again, when

you as a small trader get a good fill, you've probably noticed that

the trade always turns out a loser. You expected the market to

move directionally, as all your indicators were in favor of it. You

put your order in, and you got a good fill, because the market

really hadn't responded to your indicators at all. Your indicators

did not break the bounds of liquidity, and the market, having seen

the failure, was going to go in the other direction. This is an

example of a subtle information flow in the market, just like the

noise factor in the bean example I gave earlier. The intermittent zone between phases of dominance is a very

difficult area to manage and interpret. It is a lull or a pause in

directional activity. The market activity during a lull tends to be

counter to the dominance, and it's difficult to judge at times when

the lull itself has turned into a new dominance. Also, one begins

to anticipate it occurring as the markets move directionally faster

than normal. The tendency is to get out after a rapid move and

take a profit, with the idea of getting back in during the lull-but

in the best of situations, the opportunity to get back in just doesn't occur very often. It is necessary to have a good understanding of

the market's background in order to keep control.

During the past several decades, as markets have grown in importance and attracted more participation, changes have taken place that have affected what are mistakenly thought of as mar

ket internals like support, resistance, retracements, trend lines,

etc. , and the effectiveness of ordinary trading decisions and fi

nancial controls. In the past, every vertical reference was severely tested by liquidity, and it, being horizontal, made the vertical

internals effectively horizontal as well, since the liquidity at the

reference point was what made them hold. In the old days, a flare

up of uncertainty would be assessed as to degree by the liquidity, and was automatically traded against most of the time. Thus, in

ternal levels could be traded repeatedly. Now, the internals have

50 CHAPTER FIVE

a different meaning, due to the lack of horizontal testing from liquidity.

In today's markets, any unrelenting directional force is essen

tially free and unrelated to anything that has gone before, and

there is no attempt by the market, as there was in the past, to

create such a relationship. The "internals" we listed above are

really externals, in that the market is not trying to produce them;

the market is trying to find efficiency, and they are a side-effect

of the market's effort to process out inefficiencies. In removing

inefficiency, the market leaves trails or tracks. These trails or tracks

do not relate to the next flare-up of inefficiency to come into the

market. But, when you have floor liquidity, it is injected into this

process, and these so-called internals found their meaning basi

cally because people thought they would. Changes in liquidity

and dominance have sent the market back to its fundamental base of processing out inefficiency, which they previously had hid

den.

Basically, the market has removed the meaningfulness of domi

nance and l iquidity; both need to be redefined in principle. To be

useful, any measurement of a quantity like dominance has to be a

reflection of the market's single unrelenting purpose. It's the

degree of efficiency that provides the meaningful measurement,

as it has all along for the subjectivelintuitive trader. It provides a

background/foreground basis for trade determination, as well as

being the only true market internal. It is the highest form of control a trader can hope for. And, as we said early on, internal con

trol is basic to all forms of business. It represents a sound busi

ness principle, one you have to have to succeed. Let's take a look at the commodity market's change through

the years, and classify it broadly in terms of efficiency or non

efficiency as a base characteristic. In the early 1 960's the market

tended to be more efficient, so much so that the percentage of

efficiency was a good fraction of 1 00%. This condition allowed the market to be in control of itself-short term changes in effi-


ciency were traded out fast, and there was no real internal imbalance.

In the seventies the percentage of efficiency dropped consid

erably. But in both instances, the markets held whatever general

range of percentages they had for a substantial period of time

before changing, and we were given background by default. As

we look at the late eighties and nineties, we see such characteris

tics changing very fast; efficiency pops in and out of control of

the background of the market. We now need to know and assess

background.

This indirectly shows how important background is, and how

dependent we are on it. In the more consistent eras we could

establish what worked for our trading programs, and proceed

through a considerable period of time with whatever edge we

had found. In addition, we had a stable liquidity to supplement

the existing condition whenever the market was in the process of

changing. Liquidity was an extension of the condition at the time,

and was a counter-force to change. Therefore change was not

abrupt and one could deal with it. I can remember when I first

started trading in Chicago that it took several weeks for a market to really change. I also remember holding positions for several

months with most of the settlement prices being successively fa

vorable to the position. Markets were mostly two-dimensional, in that they had both the horizontal and vertical dimensions equally

active; most of the time one could buy breaks or sell rallies, and

if caught with a counter-directional trade have whatever external

controls one was using work to some extent.

In the current era, change needs to be the focus. The more modem markets of today are a great deal less two-dimensional, as directional moves are not countered by as much liquidity.

Therefore, the one-dimensional verticality is more pronounced, goes farther, and lasts longer. As traders we must make the ad

justment in our programs so that we fit this new scenario. When

I first started trading, Bill Griffin, Sr. was a very good position trader. He once came up to me at the end of a day when I had

52 CHAPTER FIVE

been trading opposite the way the market was going for a little longer than I should have, and he asked me if my goal was trying to prove that I could be stupid forever. Every time I think I have

to make a change and I 'm debating about it, I reflect back to this

encounter.

The side effects of this new market behavior are many, but

one thing traders should review is how they were successful . If

success in the past came from the errors of others instead of be

ing directly related to market opportunity, then the prospects are

dim. The type of markets that are in place now are going to re

move this source of success , as they really do punish mistakes

harshly, and this in tum will reduce trade, and make it more de

manding. More people understanding the current climate of op

portunity will provide for a better, more sustainable basis for

growth. This is no different from the original reason that got me

started trading -trading as a marketplace for ideas .

As I look back on my experience with market discipline , I

feel very fortunate to have stumbled into the correct path to my

future . Time and continued effort were big factors in my devel

opment, as learning new ways to do the same thing was more or

less forced on me . Early in my trading career I learned how to

determine market discipline by looking at my results , and asking

questions . The markets , being dominated by efficiency, provided

a safe environment in which one could learn from mistakes. That

environment has gradually shifted over the years to be one that is

more difficult to learn in .

It would be very hard to follow my earlier program today. If

one takes a modem approach, it just means doing the same thing

in another and what I think is a better way. The key is to get on

the right path and learn the basics of how markets work. Incorporate this insight into computer programs that can manage and

process enormous amounts of data. Learn to distinguish between

opportunities, and limit your trading to the best of these. In other words , you are giving yourself a chance to learn, in that most good opportunities will take care of themselves regardless of any struggles you may have to personally deal with . It took me years

to get enough exposure, while today, using a computer, I can get


more in a week than I used to get in a year. My current program is composed of exactly this . Simply, the more I see, and the more I do, the better my chances for success .

54 CHAPTER FIVE

CHAPTER SIX

How the Market Defines Itself

Producing efficiencies is the way the market continually de

fines itself. Efficiencies can be highly concentrated , as when the

market is caught in a small trading range for weeks at a time , or

fragmented, as when small horizontal patches show up in the

middle of extended vertical moves . To be able to read the market objectively requires a screen display or print-out that can faith

fully represent the underlying process in a readable way. We need

to start with the market's most fundamental definition of self, its

dimensionality, the way it can be measured and recorded. In

moving beyond a simple ticker tape or list of numbers to a graphi

cal representation , it's critical we be able to view and understand

the internal market organization unfolding .

Graphically, then , we want to catalogue the market's process

objectively. The first requirement is to establish the dimensionality of the market. Second, an objective display mechanism needs

to be found. This can't be imposed from the outside , since it has to have the capability of freely and completely expressing the

dynamics of market activity. Looking at the market from the viewpoint of efficiency, if one

answers no to a static condition , believing the market to be dy

namic , one would have to conclude that the market would both

be efficient and non-efficient. From a practical view, you would say that it has two dimensions , a vertical (price) and a horizontal

55

56 CHAPTER SIX

(time) . In bringing both these views together, the vertical would be non-efficient, the horizontal efficient. Each of these viewpoints leads separately to the conclusion that the market has two dimen

sions. These dimensions are the basis of the way to measure the

market .

Fortunately, the computer screen is set up to be at least two

dimensional for viewing graphics . With a representation that com

bines a vertical and a horizontal , all the data can be captured and

displayed throughout the market's development . The Market Pro

file notation we've introduced already demonstrates the poten

tial for accomplishing this.

Next, the outer limits of possibilities of dimensional move

ment need to be understood . Can the market move vertically

without any horizontal movement taking place? Can the market

move horizontally, without any vertical movement? Can they

move simultaneously? Can they move not at all? The answer is

definitely yes to all of these questions . It's the mix of dimension

ality that defines market condition. Change , then, can be illus

trated and chronicled by dimension . Measuring dimension would

give the market an objective means of expression relating to its

condition . The general history of the market was to be mostly

two dimensional and thus in control of itself, due to the fact that both the vertical and horizontal phases were active, with short

bursts of one-dimensional vertical activity. The market also had

its liquidity to lessen the impact of the vertical phase . In the past, it usually reverted quickly back into the active two-dimensional

comfort zone of what can be termed moderate efficiency. In the

last few years this situation has changed, and now, as we pointed

out earlier, the one-dimensional vertical lasts longer and goes farther.

When I first started trading , the markets were more horizontal

than vertical . Over the years this relationship has changed many

times. Change is always de-stabilizing and has to be gotten used

to. The change in market activity can always be described as a shift in percentage of verticalness versus horizontalness within a

How THE MARKET DEFINES ITSELF 57

100% cap. (In practice, neither actually ever gets to zero.) It should be fairly easy to establish the best parameters within this spectrum for any trading approach . The place where there is little or

no vertical movement would be characteristic of efficiency; re

gions where both dimensions are active would be a two-sided,

moderately efficient market; and where only the vertical was ac

tive is a one-dimensional, non-efficient market. It's important to

observe here that change and condition of the market can be seen

to be made up of dimensionality. It's through this medium that

we can objectively express captured market data.

The market is in general control of itself when it is actively

gaining efficiency, and this usually takes place when the market

has both active dimensions working: a condition that we have

become used to , because it is more conducive to trading . It is a

more orderly flow, even though the dimensions may work at ir

regular or sporadic intervals .

When either dimension is moving separately, control is with

capital inflow/outflow (inefficiency) . When the vertical is in the ascendency, inefficiency is present and is dominating the mar

ket; when movement is horizontal , it creates a background that is

highly vulnerable to change . The market expresses itself directly

in the ratio of its dimensions .

Once we understand the basics of dimensionality and how to

measure it, the other thing we need to monitor to have a complete

picture of the market's condition comes from what I call market output. The output, which is the efficent price area, demonstrates

what the market is trying to accomplish through its self-organizing system. An overlay of this on top of dimensionality would

provide more control , as the precision would be enhanced; we

would know the circumstances under which the market was pro

ducing its output.

If we were in manufacturing, for example, we might change our expectations of output based on the fact that today's plant shift was operating at half capacity due to the installation and

testing of a new machine. In the market , if the conditions are

58 CHAPTER SIX

really perfect, and the market doesn't go anyplace , we know that the potential for the trade is over. Conversely, if conditions are

barely adequate and we're getting good results , we know we can

expect much better results under better conditions .

I once discussed this problem with one of the trading floor's favorite old-time traders , William Emory Uhlman, a member since

1 927 . He just laughed, and remarked that maybe I should have taken a little bit more engineering in college , or done a little more

work on the farm, so I would be able to understand that wagons

are always moving faster at the bottom of the hill than they were

at the top .

In looking at market output, pit, screen , or specialist based trading are all operationally the same. Differences in these types

of markets would be capacity, depth of participation , and so on .

Participant activity allows information to be produced and con

veyed to those using or desiring to use the market . As traders , we

want to be in control of this type of know ledge . It is a free market

expression . In looking at market output, a better understanding

of its self-organizing mechanism is called for.

A meaningful amount of data is composed of a vertical data mass that is large enough to have allowed the market to gather

participants . This means that somewhere within the data mass the two vertical reference points will have been found and estab

lished, creating a vertical base . The background pattern , or data

makeup , of these bases will always be different, due to the fact

that volatility is never the same . This , by the way, is an added

factor in the difficulty of reading the activity of the market while

establishing the vertical references . But, once the predominantly

vertical phase is done, it anchors the rest of the development, because the market now has established a vertical base to work

within in trying to bring itself to efficiency.

The information coming from the market early in this process

is very unstable, and when the process is final the information is very "late." It 's only after the fact that we know that the boundaries of the range have been established. For example, a market

How THE MARKET DEFINES ITSELF 59

goes from 10 to 30; while trading at 30 , it looks as if it is still

going to continue moving vertically. When it trades down to 20 ,

then we can see that 30 was indeed a valid high reference. Once

both vertical reference points are in place, the market turns its

effort to trying to establish a fair price area within the vertical

range- a consensus price for those involved. This fair price area

produces more timely information because the characteristic na

ture of its development is more horizontal . It is more readable

sooner because we're dealing with lesser volatility and a smaller

range of data. Also, more importantly, it is the most consistent

market information . All the various volatilities have been pro

cessed out. The fair price area is a common denominator in cross

referencing a market to itself through time as well as to other

markets , because the resultant of processing volatility out of a

market tends to be consistent. A fair price area is just that.

It is change that starts the whole cycle over again. Change

impacts fairness by calling for vertical movement away from it

in order to reestablish fairness . Or it may be that it just stops the

partial development toward efficiency prematurely, and moves

to establish another vertical reference point before once again

looking for contained development and consensus . Consensus

areas , or fair price areas , are the easiest to read and most valuable of all market-produced reference points , in that the market uses

them to anchor vertical movement; vertical movement being what

we're trading for, since it gives the most opportunity. Instead of

the late information of the vertical price extreme in the earlier

example, the fair price area or consensus area becomes the new,

more reliable, readable extreme that serves as the basis for verti

cal development. Only the remaining vertical point needs to be found. Consensus is needed in order to begin the market process

all over again . And the consensus price is the market output . The result is a true self organizing mechanism. Vertical back

ground is varied, while consensus output is more standardized

(in a relative sense) , and therefore more readable. Consensus output allows consistent readability, which is the best basis to go

60 CHAPTER SIX

forward with. When we combine the free expression of dimensionality with the consensus output on an objective data screen ,

it's only then that the market defines itself. It shows us what it

did, what it is doing and how it has changed.

CHAPTER 7

Capturing Market Data

The purpose of capturing the market on a screen is to put it

into an objective format. Just having the data on a screen is not

enough. The market is two-dimensional, in the sense that it is

vertical and horizontal and the data representation needs to re

flect this fact. The test is to be able to see independent movement

in both the vertical and horizontal dimensions. If you can, you've

achieved your goal. Most objectified screens have a forced non-varying movement

in the horizontal due to the use of chronological time. For ex

ample, if the market in development of the horizontal should have

shown only three slots of usage (because no price was hit in more than three half-hour periods), and actually shows five, just be

cause five was the chronological time span, you have not accom

plished your goal of objectively displaying the market. In fact, you have a one dimensional data base, and it's therefore entirely

subjective, since it cannot faithfully represent the two-dimensional

aspect of the market.

It is very important to understand the proper use of the hori

zontal and vertical axes in developing an objective graphical representation of the market. It is logical to assume that the market's two dimensions, the vertical and horizontal, would fit with the screen's capability for two-dimensional display. The vertical axis fits, because it will record any vertical price that the market uses.

6 1

62 CHAPTER SEVEN

The horizontal axis presents a problem because it's normally as

sociated with chronological time, which proceeds at a fixed pace.

What is time? We naturally think only of chronological time

since its use has become so ingrained. But in the case of market

definition, it is totally inadequate . Do we really need chronologi

cal time for order, or do we just automatically assume so?

Development, which is horizontal , is the real market time.

Development begins with initiation of a vertical move that has to

be brought to efficiency. It continues after the establishment of the vertical boundaries (outer limits) , when the market shifts into

more of a horizontal phase. This activity cannot be forced to

move in lock-step with chronological time. Forced chronologi

cal time does not allow for free two dimensional expression. It

makes the data one dimensional, which leads not only to repre

sentational problems, but to control problems as well .

Chronological time has no relationship to the market's devel

opmental process . The market's development is almost always

inside of an established vertical range, and on that basis is hori

zontal , because the vertical is not growing . The development of

efficiency represents the time clock of the market. If develop

ment is interrupted , the market can move to extend the vertical

and then start the process towards efficiency all over again. Re

gardless of the circumstances , we must look to development as the timing mechanism for the market: development begins , is at

1 /4 , 1 12 , 3/4, and is finally completed. The progress of development is shown in the proportion of horizontal slots used versus

those available , where availability corresponds to chronological time . (See the discussion of profile in Chapter 3 , pages 29-30 .)

This concept represents a huge step toward tradability, since

traders need to fit their trades to a naturally occurring market event, rather than to outside parameters . A negative effect of

using chronological time is that the data base is forced into a vertical mode, which , with a vital dimension of information sup

pressed, makes definition and control extremely difficult, since

CAPTURING MARKET DATA 63

efficiency is very hard to recognize in a vertical presentation of market activity.

False assumptions have caused a lot of financial wreckage,

not only in our industry but others as well. What has been false,

and is false, is that technical analysis on a one-dimensional data

base can capture the essence of what happens in the market. This

type of analysis, which has been portrayed as objective, has never

truly been so. There is evidence supporting this contention within

just the short passage of time since I started trading. There has

been no appreciable increase in favorable results within our in

dustry compared to the past, notwithstanding the advent of com

puters and the influx of very bright technical people from other

fields. This is not saying that individuals have not done better; it

is that, if we had objectively conquered anything, general results

should have shown some improvement. While our industry has

grown both domestically and overseas (a factor that tends to keep

the percentage of success down), it shows growth due to need

rather than a breakthrough of new knowledge. This problem can

not be ignored or glossed over; it needs to be addressed in order

to find objective market definitions that will definitely improve

results and provide industry growth at a much faster and a more

sustainable rate.

64 CHAPTER SEVEN

CHAPTER EIGHT

The Importance of Two-Dimensional Expression

The most important discovery related to Market Profile was

made by Mike Boyle, vice president of information systems,

Chicago Board of Trade; Bob Jirout, the head of the department

at that time, also played a key role. This discovery was the data entry system that allowed the market to evolve naturally in mar

ket time on the horizontal axis within the day time period. It also

made the base of the bell cur�e vertical rather than horizontal ,

allowing efficiency to be portrayed through horizontal develop

ment.

I met with Mike and Bob in Bob's office one afternoon to discuss developing the profile as an on-line proxy for volume

data, in an attempt to give the off-the-floor trader the opportunity

to make the same type of observations that I made on the trading floor. The earliest volume report was released each day after the

first run of the clearing house at around six p .m. , so such a proxy would fill a real need during the day. At that time the volume

data was broken down into segments of CTI codes (Commodity

Trader Identification codes, such as commercial trader, local, lo

cal off floor, and other) , and a volume value area of 70% was

calculated to approximate the first standard deviation derived from the bell curve discipline . (See the end of Chapter 3 for a discussion of the bell curve .) A flat presentation was the mode of dis-

65

66 CHAPTER EIGHT

play: volumes were given as numbers opposite the prices. (An example of one of the first such reports is given at the beginning

of Chapter I .)

We planned to put the profile opposite our volume data in the

liquidity data bank report. This would demonstrate the sound

ness of the profile method, if, as we expected, volume corre

sponded with the profile mass; i .e., where little time was spent

there would be little volume, and where a lot of time was spent

there would be a lot. This would validate our concept that price

plus time equals volume, and would mean that the profile did

indeed capture market activity. It was, after all, a record of ac

tual usage of the market by participants. And, in fact, our expec

tation was fulfilled: there was a close correspondence between the width of the profile and the volume at each price level.

Briefly, the formula for the profile was, as we described in

Chapter 3 , to use the ranges of the half-hour chronological bars,

using letters of the alphabet instead of numbers to represent the

range, in such a way that the accumulation of letters would sig

nify acceptance of the corresponding prices in the lettered mass

of the profile. As the market traded during the day, each live quote

that increased the range of a half-hour time period would build the profile on-line, and thus approximate the actual distribution

of price usage by market participants.

It was our intention at the meeting where the profile was de

veloped to have the profile data mass also reflect the properties

of the bell curve, especially its first standard deviation. That is, we expected a daily profile to look like a textbook illustration of a bell curve, with its first standard deviation corresponding to the

70% volume value area in the LDB (Liquidity Data Bank), and

with the base being vertical rather than horizontal. The meeting ended after about twenty minutes, and Mike said

that it would take about two weeks for him to prepare something

for us. A little before the end of the two week period, Mike was ready to show Bob and me his ideas. He had done it a couple of ways and I could immediately see the one that was just perfect.

THE IMPORTANCE OF Two-DIMENSIONAL EXPRESSION 67

We decided to go with it. The decision was visual , based on

resemblance to bell curve examples in a textbook, and volume

data in the first standard deviation was perfect proxy of the pro

file. Because the correlation was so exact, we felt that we had

indeed captured the market.

It was much later that we added the S&P to the floor data

terminals . I was concerned to see if the relationship would hold

as far as getting a realistic profile that mirrored the volume data,

and it turned out to be as close to perfect as possible . The key, as

stated earlier, was Mike's method of data entry in the two-di

mensional display that allowed the data to form a bell curve, which

was our main purpose. It also allowed natural market time to

evolve on the horizontal axis, a fact we were not aware of or

interested in at the time. That is , chronological time was sup

pressed during the day, although the day and beyond were still

chronologically oriented. The result of this type of data arrangement was to allow mar

ket usage to determine the number of horizontal slots used. For

instance , consider a six hour trading session. There would be 1 2

half-hour opportunities (and thus 1 2 half-hour bars) on a chrono

logical time scale. With the Market Profile data arrangement, there

would be a maximum use of 1 2 slots , but usage could be less if

no one price was hit in all 1 2 half-hour periods . The difference would be the amount of horizontal usage on a comparative basis to other days.

In the early 1 980 's , we were totally oriented to trading and

trading disciplines , and were looking for objective data to help

people trade . We were not aware of the deeper significance of

this finding . I am going to insert here a statement from Mike

relating his side of the story, which is quite interesting and re

vealing .

In approximately 1 982, when Pete and I first sat down to

discuss how the Liquidity Data Bank physical presentation

might look , the computer systems in place at the CBOT pro

vided few display alternatives . The nature of this information

68 CHAPTER EIGHT

and the requirement that interested parties have access to mar

kets of their particular interest necessitated the use of then state

of-the-art alphanumeric display terminals . ( The first PC was

commercially available sometime around mid 1 98 1 , if I recall

correctly.)

These terminals provided the typical 24 lines by 80 charac

ters of display capability, and although some limited graphics

could be constructed , the computer system which supported

the LOB did not have such software support .

As a result, Pete's input as to what types of information to

display, and how the time factor (i.e . brackets) would be repre

sented were viewed in light of this physically restrictive dis

play technology. In addition, the time representation whereby

the brackets were collapsed at a given price level was also a

limitation of the 80 characters per line restriction . In addition ,

a collapsed display effectively made the programming easier

since the software did not need to make any determination as

to what column to place a specific bracket character.

Also , in planning the ergonomics of the display (i .e . , keep

ing a price per line approach) , the possibility existed that the

number of unique prices would be higher than the 20 available

lines of displays (assuming about 4 lines of header type infor

mation are needed) , which also made a strong case for the col

lapsed bracket display per line (price) . As of this day (July

1 996) , the CBOT computer system displays of Market Profile

remain in place today, via the same terminal-orientated for

mat. While terminals are often replaced by PC 's , a terminal

Emulator operates on the PC so the user interface established

in 1 982 remains today.

As we look back on this period of time, we are going to find that the sum of the parts was greater than the whole. The current

Market Profile methodology is something we were not even think

ing about . It came about because an effort was being made to do something toward more understanding of markets , to make them

more tradable. This data entry system can be and has to be used

in all creative data arrangements .


Almost all data arrangements up till now have been in support of a search for trading parameters that are immediately back

tested as to financial goals and requirements . Most of us never

get beyond the objective trading parameter stage , especially if

we've been successful . Our dreams never get beyond a trading

system that does nothing but print money, this being construed as

solving the market in the everyday world. In reality, because of

the constantly changing markets , this is not highest goal we can

strive for.

The new view comes more from awareness and experience

than from any direct change . This means having a market focus ,

on market disciplines related to the market as a whole , rather

than a trader or financial focus . This attitude has been able to

move our market operations to a higher plane , giving us a sound

business approach. It gives us an opportunity to understand what

we are about, and what we are working with. We can assess how we are doing with it, where control really lies , what the condi

tions are , and how they may have changed. The ability to answer

such questions objectively allows a whole new approach to trad

ing , and the key to this ability is to create a truly representative

data base. This is the new role for Market Profile-as a data

base. It has the means to accomplish what no other data organi

zation method does . It 's vitally important that any data arrangement allow the data

to be evaluated relative to its context, which lends support and

smoothness to change. By allowing the singleness of purpose of the market to express itself in varying ways , we allow this to

happen . The data entry system can produce a Market Profile data

base that represents what the market is doing and allows the mar

ket free expression , giving us a formalism that is true and repre

sentative . This is using Market Profile on the highest plane possible.

Once the data are correctly organized, there are two additional

aspects that come into play. First, computers: in trading they have always worked best in defined objective formats like arbitrage .

70 CHAPTER EIGHT

Second is trader control . Now, in order to be successful, traders

can work to gain control over the market process by gaining ob

jective answers to their subjective questions about such matters

as dominance and background. Answers are available that come

directly from collected market background and foreground in

formation , and are communicated in a uniform language or for

mat: in terms of efficiency. This produces a framework for ob

jectifying the market.

Let's use as an example the concept of lull introduced in Chap

ter V. A lull is an interruption in the dominance that propels the

market directionally. As in most vulnerable situations , a deterio

ration takes place to some degree in whatever has been going on,

and the lull is likely to be a stressful time calling for adjustment.

We can ask our data base to define it, compare it, compare dete

rioration to when it occurred previously in this market, to other markets , to the condition of all markets , etc . Is the lull becoming

dominant? What are we going to do when it's over? Is it over? Why? How do we know? With dominance and lull defined by

objective market conditions , such questions can be posed and

answered . Understanding, experience, and market differences are all com

parative and relative . It is easier to deal with this relativity if

there is a standard data base that is truly representative . Finding the self-organizing mechanism within the market that is depen

dent upon the completion of efficiency was a conceptual break

through. It would never have been possible without the data en

try system. The details of finding it are like those of most good

things , in that the discoverer is looking for something else . Also ,

since the concept is completely out of the norm of our logical behavior related to cataloging market activity, the eventual successful direction had a very small chance of being pursued .

A great deal of my early data arrangement was visual . It controlled what I did. It was a very limited approach because I was trying to force the output. If the data for a day did not create a

perfect little bell-shaped profile , I would combine data until I got


one . This was a logical approach: the larger the data mass , the more likelihood of finding efficiency, as efficiency was commonly

expressed in this manner. I could only see opportunity in this

context. It's logical to want to always trade order, but the oppor

tunity is often in disorder.

Other than intuitively, I was not aware of this . I remember

when we first started with the software; we were actively arrang

ing the data by breaking up and combining daily profiles, and

were having a good deal of success . I said that it was wrong to do

it that way. Most of my supporters were really taken aback that I

could drop what I had been doing for something so seemingly

unreal . My inability to logically explain the change made mat

ters even more complicated. I admitted as much and asked them

to trust my judgment. The result was a discovery process that

eventually led to a data arrangement algorithm that produced the

foundation for all our future accomplishments .

A good example of the importance of accepting disorder is

the self-organizing methodology displayed on the screen I call

"Page Two" in our software . The output , or resultant, from the

data arrangement algorithm was consistent in meaning. What

was not consistent was the background. We did not use a single

output scenario; instead, the triggering of a new cycle was data

dependent rather than predetermined.

When we released the software to our clients , the program

mers responsible for the program, Bill Pollack and Gordon Kummel , received a number of calls concerning what appeared

to be several inconsistencies in the program. The output was different on different machines, as a result of small perturbations in

the data received, plus some internal procedures of the software . This was counter to the rigid order most of our clients expected,

which in and of itself was quite normal. In addition, the market

output would mostly take place in the present, and be located

within the data itself. At other times, though, the program would

mark the resultant back in the data, saying in effect that it was not immediately recognizable at the time . So our resultant would

72 CHAPTER EIGHT

sometimes occur well after the fact. When the resultant indicator is outside the data, and late, it has its own significance, in that the

associated move is usually quite strong . The superficial lack of

sameness is simply a reflection of reality. We are not trying for

the impossible , but the practical . In fact, the output actually rep

resents sameness of a higher and more functional order.

I personally thought that .all of the irregularity was a great

feature, in that we experience this type of output in the markets

all the time . In the active trading pits , all the traders do not get the same feelings or trade indicators , yet the information is there .

The difference is in the way they subjectively organize the data,

into different size groupings that give a distinct feeling for the

same information. If this weren't the case, if all traders had the same perceptions all the time , the markets would never trade . In

our software, we avoid the problem of everybody getting the same

conclusive information in the same way. This goes a long way

towards rebutting the "self-defeating" prophesy, which says that as soon as a good trading system becomes widespread, it fails ,

because too many people are trying to do the same trades at the same time.

Let's consider the idea of "disorder" in the light of the graphi

cal display systems currently in use, in comparison to the ticker tapes and clacker boards of the past. Is market change informa

tion getting out through the current systerms, or has the informa

tion been narrowed from everyone doing their own organization and interpretation to a mere trading focus, where everyone is look

ing at the same half-hour or hour or five-minute bars and the

same studies to decide where to trade? The functionality of this

process , not only for the trader, but for the exchanges that are

trying to disseminate the information, is questionable . Why is the information being distributed so impoverished in

comparison with the information available on the floor? Basically, the information is processed and packaged for the conve

nience of trading programs whose net result is a profit or loss , rather than market information. How many opportunities are de-


fined per minute, or per quote , versus actual opportunities that are present in the day? How many updates do you need to moni

tor a winning trade? First a lot of information is filtered out, and

then noise is added back in, by providing and continually updat

ing various studies , giving the illusion of a richness of informa

tion that is really no longer there .

The essence of floor information is to take a segment of the

activity and assign it to a direction, and then view it in terms of

one's background and experience of similar situations , rating it

as being at, above, or below normal for similar circumstances.

There is no one outright order or price in the stream of informa

tion that is as important as background. If a trader can use this

information to establish the existence of a barrier to a directional

price movement, it makes trading a lot easier, since all the indi

cators in that direction are going to be invalid. The goal of our

software is to allow the trader who is not on the floor to simulate

this experience by constructing a background, finding similar situ

ations , and assessing the market's performance in relationship to

this information.

The bottom line is that, despite some differences in the output of our software on different machines , the meaning of the output

is consistent with the data sample size being processed. On the

floor, the markets currently trade very well , due to the individu

alistic way the traders view the information in relationship to

what they 're doing . The information provided by the software

allows traders to understand what the market is doing in relation

ship to what they are trying to do, and thus has retained the indi

vidual value concept. The main reason for mentioning this issue here is to illustrate

how ingrained a sense of visual order and sameness is for most of us . Prior to the discovery of the new output algorithm, and

immediately afterward , I did not know what I had done . It was

really a higher sense of order than what I could immediately handle . The new output was a free market expression that above all was consistent, and I recognized that aspect of it. All the vola-

74 CHAPTER EIGHT

tility had been processed out, leaving consistency. Logically, vola

tility cannot be neatly cataloged, as in reality it does not leave footprints of the same dimension. The result of our new algo

rithm was an entirely free market expression , which went a long

way towards furthering our new data base concept.

The overall benefits of this data base are many and in my

opinion complete: it gives you everything you need to trade .

Opportunity can be defined and evaluated. Expectations can be

measured against reality. Experience and knowledge are the fruit

of natural occurrences . Growth of the trader control process can

begin. The ability to be in step with the market increases as the

quality of the trading opportunity improves , because the oppor

tunity is related to natural market development instead of just

financial management. Natural market events are at the heart of

market discipline . Data arrangement with this type of result is

possible only because ofthe two-dit m�ma� e t�

CHAPTER NINE

The Bell Curve

My interest in the bell curve began in 1 958 , in a statistics class at Berkeley. A statement in the textbook about "bringing order to

chaos" got my attention. From the beginning, I wanted to use the

bell curve as the basis for formulating a market discipline . I could

see that it had many qualities that helped reveal internal market

organization. The most important was that it presented a visual

sense or feeling of what was going on . At first, I was much like a first grader with a coloring book, tracing the outline of the mar

ket within a bell curve , and this was a great boon to my program

of exploring and using market discipline . When the time came to

formally develop Market Profile, after I had been trading for over twenty years , I could draw on my experience of always thinking

of market activity in relation to the bell curve . The bell curve discipline, being a dynamic two-dimensional

data organization tool , fit the framework of my practical experi

ence . Within the chronological day timeframe, I as a floor trader

traded according to how the market felt: was it slow, tired, responsive, tight, or what? I would compare these intuitive terms to the profile . Each discovery always led to the next, and the

next, and allowed me to move towards a more complete understanding .

Statistical theory states that in a bell curve, almost all data

points will fall within three standard deviations from the mean

75

76 CHAPTER NINE

(the average price of the entire data sample) . For our purposes , we use the mode (the longest horizontal line) as a surrogate for

the mean; it's much easier to locate visually, is often exactly the

same value, and gives good results . The mode is the anchor for

development as the data stream continues. At first glance , it ap

pears to be a fixed quantity, but in fact it adjusts to increased

activity as more data comes in, making it dynamic .

The standard deviations are groupings of the data mass being

observed, and provide the basic organization within it. Each one

has a prescribed amount of data in it, and the total of the three is

very close to 100%. The first standard deviation has the most data at approximately 67% , the second has roughly 26%, and the

third about 7% . These standard deviation intervals are used to

capture and define data . Figure III-3 shows a symmetrical bell

curve with the standard deviations shaded in; a more off-center

data mass would not create such a pretty picture , but the basic

idea is the same. As I began to develop insight into the market disciplines that

controlled my trading, I also incorporated the disciplines of the

bell curve as more or less distinct unto themselves . I benefited

tremendously when I sensed an ever increasing unity developing

between the concepts related to the bell curve and what I had

been doing all along in my trading . I gradually became aware of

how it all fits together as a single entity. In other words , there

was no reason for separate and distinct analysis , because the bell

curve was able to accommodate all the properties of the data stream that we were collecting and present it in a natural way.

Personally, this was when it all came together for me . When the

market disciplines and the discipline of the bell curve converged,

the light started to come on. Let's list some of the commonalties between innate market

discipline and the discipline of the bell curve as applied to the market.

THE BELL CURVE 77

• The market has two dynamic dimensions, vertical and hori

zontal ; the bell curve needs to have the same in order to function.

• The market uses the outer limits (vertical extremes) as a

base to begin the development process; the standard devia

tions are collectors of outer data which the mean controls .

• The market brings the data to consensus somewhere within

the established vertical range; the bell curve's first stan

dard deviation begins to develop somewhere within its ver

tical range .

• Market development time begins , proceeds , and ends; in a

market context the bell curve develops through completion

of all three standard deviations , and ends with price in the first.

• When change affects the consensus , a new sequence be

gins , in the cyclic progression of market activity; the bell

curve discipline starts a new data unit after finding a com

plete first standard deviation , again in a cyclic pattern.

• Background data leading to market consensus is varied, di

verse etc .; background data leading to the first standard de

viation is varied, diverse etc .

• Market output (consensus) tends to be consistent, repeti

tive , more of a standard than the vertical phase of market

activity; the first standard deviation is likewise standard

ized, repetitive , and consistent.

• Location of consensus can be varied within the background

range, but is mostly limited to either extreme, or to the

middle; location of the first standard deviation when mar

ket data is plotted in the bell curve is the same.

• Market sequence is from a more volatile vertical to a less volatile horizontal; the bell curve organizes from vertical

extremes towards horizontal development. • Consensus and first standard deviation are the only infor

mation-producing moving parts in their respective environments .

78 CHAPTER NINE

This match-up has allowed me to attain a focus that had eluded me for a long time . The disciplines of the bell curve that we

initially used for trading can be re-framed as market disciplines.

This means that the bell curve has been completely neutral within

its disciplines, in the sense that there are no harmful side effects

from using it, as it fits market behavior well enough to allow free

and natural market expression .

This single expression is simply the degree of efficiency present

in the market: a reflection of the process of dynamic efficiency.

From this , everything else follows. It means that randomness ,

liquidity, and efficiency are all the same, in that they are horizon

tally oriented . It means that one-dimensional vertical data bases

cannot objectify the market . It means that dominance is expressed

as non-random and non-efficient. It means that the condition of

the market is expressed dynamically as a percentage of a whole

number ( 100% ) , and that the best choice for this measurement is

the degree of efficiency. It means that background and foreground

can be expressed in the same type of measurement, illustrating

contrast between a sample and a subset of it. It means that traders

can express their trades in the same measurements for control. It

means that trader control can be internal to the market . It means that total objectivity is indeed possible . It means that we have

found the highest point of market discipline from which to begin

to approach trading . It means that we have the path to our future .

As we explore these concepts in the next chapters , I think you'll see how beneficial the bell curve concept is in bringing an objec

tive background to our aid. It also is a metaphor for our own progress, being at the outer boundaries initially, moving inward

towards the goal , and finally arriving at the single central issue

of market purpose .

CHAPTER TEN

Updating Our Understanding of Market Profile

The development of Market Profile took place over many

years . Over the course of time , changes were made, some as a

result of gaining more knowledge and some that were forced by

the market . We started at the outside rough edges of market or

ganization and moved inward, led by the ability of the profile to

educate us visually and to represent the market through time .

The underlying reality remained the same throughout, in that the

market was able to express itself dimensionally and that it was

indeed trying to accomplish something dynamically.

Early on, we generally thought of ourselves as working to

understand development, as it could be read in its various stages. Later, as everything we were doing seemed to lead to the same

type of conclusion, we were brought to a singleness of purpose

which allowed us to realize that Market Profile's contribution

really was going to be as a database from which market objecti

fication could emerge , because it was able to provide the frame

work for expressing the dynamics of efficiency. The first thing to point out is that our approach was subjective

in its early stages . The main reason for this was that we had not defined the market's purpose. We were not even interested in doing so , nor, for that matter, were we interested in objectifying the market; we wanted to trade and we were looking for objec-

79

80 CHAPTER TEN

tive trade parameters . We did not understand much other than

that. Although the profile did take us out of chronological time

during the day, it did not take us out in larger time periods . We

did not understand the difference between chronological time and

market time anyway. At this point, chronological time and mar

ket time were one and the same, due to the fact that the floor

population was really in control of the capital flows. Not that

they had all the money; it's just that all money entered and exited

during their market hours , and whatever was going to influence

the market was in most instances readable from the floor envi

ronment. There was no reason to be aware of any difference if

one was not looking for it.

To further illustrate the subjectivity of our approach at that

time , I can remember giving classes where I would be discussing

indicators , and I would weight them for that occasion . In short

order, a situation would arise were I would use them in a differ

ent context, and I would adjust the weights . In other words , the

use of the indicators was somewhat subjective based on the market context as judged by the trader. The markets were very read

able because floor liquidity was very high, so when we had an

indication of direction it was usually a dominant one that either carried on or held the general price area, giving us time to ex

ecute vis-a.-vis entry/exit.

Our objective trading parameters arose from the discipline of the tools used to create the profile , i .e . the data entry system and

the bell curve. We were incorporating market discipline into our

work gradually because it was there both in a conscious and nonconscious manner, mostly due to the visual aspects of the profile . We could see things better than we could explain them.

For the benefit of those who may be familiar with earlier ver

sions of Market Profile , and also to show how our later ideas refined and improved on our early work, I 'd like to go back and reconsider some of the early Market Profile concepts . Looking first at the data entry system, and the task of creating a dynamic

UPDATING OUR UNDERSTANDING OF MARKET PROFILE 81

relationship between the vertical and horizontal dimensions , we used the following terms:

range extension: This was a vertical movement beyond the first hour 's trading range (which we called the pioneer range) . It

assumed that after an hour the floor liquidity would be in control ,

and that this event would be the result of dominance.

type of day: We were still mentally tied to chronological time,

so we classified day activity into four types . First were normal

days -those days where range extension was very slight or non

existent. We would use this information to help us understand

expectations; we'd say something like , "In this case , it isn't go

ing to go a lot further, so let's get out," or " let 's go short ," etc .

Next in line were what we called normal variation days , those in

which the range extension would have doubled the original hour's

range . In terms of what we might call offensive versus defensive

trading , these were a little more offensively oriented in that we

would trade for them because the potential range was larger; if

we did not get a normal variation day then at least we would end

up with a normal day, which would be disappointing but would

not hurt us . Trend days triggered the most aggressive of all trading programs , but we tended to miss them more often than not.

You almost had to anticipate them, because in those early days

we did not like buying bulges or selling breaks . We consoled ourselves with the thought that at least we were not opposite the

trend . This type of day had two distinct patterns . The most obvious was the double distribution , where two bell curves would be

stacked one upon another. The other was more of a steady grind

ing affair, in which the horizontal width of the profile was usu

ally not more than four time periods (slots used) . Also, we noted that trend days at times would be a good exhaustion indicator, as

the market's opening the next day was usually just slightly different from the close . Trend days also tended to close on the ex

treme . The last type of day was what we called a non trend day. It was a day where the vertical range was very small and the

market was mostly dead and horizontal . They were a favorite of

82 CHAPTER TEN

position traders , as the market would tend to tum around and go

opposite from the way it had been going when it got to the non

trend day. Further, if it did not change directions , it usually traded

opposite to the previous day and then continued in the original

direction at an accelerated rate . Later we added another type of

day called a neutral day. It was similar in meaning to the non

trend day and physically had a range extension in both direc

tions, but it was a lot more active .

TPO's: "TPO" stands for "time price opportunity" ; in other

words , each individual letter in the profile . The principle behind

their interpretation was the relationship between the high TPO

line , or mode line, the price in the profile that had the most use , and the imbalance of usage above and below this line as it related

to the developing profile . We noticed that the market tended to

go directionally to the short count side. The reason it did this

was that the high count side was more horizontal and had reached

acceptance, and that the market had generally moved to get there.

This was quite important because it meant that the dominance

was being reined in by participants . Also, if the market did not

have a move to get to the mode, there really was no dominance to

deal with. The need to find efficiency would create a need for

this range to be fair, so the market would tend to trade above or

below the high TPO line to fill out the profile in a balanced way.

failed auctions: In terms of immediate acceptance , failed auc

tions were the most popular of all the concepts . They seemed to

work in spite of the various interpretations used, and were easier to objectively define . Physically, the profile would have a single

range extension (only one TPO) beyond the first hour's range .

Failed auctions were used in many ways, some of which I 'm not totally aware of, but mostly based on two observations . In the

short term (a day or two) , the market would exhibit a propensity to move opposite the failed auction's direction, and after three to

five days it would begin to move to take out the failed auction , and it would then have a rather significant move that was sustainable over time.


In hindsight, the real market factor behind these observations

had to do with floor liquidity (see Chapter V). At the time, it was

the dominating force in the market, and worked to counter any

directional movement, so it provided an environment that was

very readable . Liquidity was dominant in that it had the capabil

ity of usually being in control of the forces coming from other

environments . When it was not, the dominance coming from the

outside had to be significant-thus the reliability of our trading

parameters . The day profiles were essentially carved out of floor

liquidity, the way a force exerted by an artist changes a solid

block of granite into a form. The same was true of the balanced

and unbalanced bell-curve structures we developed later. In ret

rospect, the type of day related to the amount of activity and was

actually an indirect measure of the efficiency in the market on

that particular day. In a blind way, the day type classification was

leading us to what we needed to know without our ever being

consciously aware of it. Trend days were the most inefficient, while non-trend days were the most efficient. Also , the markets

were mostly still two-dimensionally active, which meant that they

were really in control of themselves , following their preferred

pattern of grinding out the excesses in a pattern that adhered to

the bell shaped curve , rather than being at the mercy of outside forces . And they gave us a background by default, by staying in

that condition for several years .

In terms of the Bell Curve we used:

extremes (3rd standard deviation): These were the very top and bottom parts of the profile . Typically, to be an extreme, an

area would not have much acceptance, and therefore would not

have much horizontal development opposite the price range. (I think we stated the objective amount was a width of three or

fewer TPO's ) . As they related to the bell curve , the extremes

were the third standard deviations . They illustrated movement away from the price area, or non-acceptance. Traders would prefer to have these extremes in a favorable location supporting their

position (under for a buy, over for a sell) , and did not like to have

84 CHAPTER TEN

an extreme positioned against them. We also used extremes in a broader sense over larger sample sizes of data, in the time infor

mation list, and in the long-term market activity chart .

first standard deviation value area: This was composed of

70% of the data, whether TPO or volume, in the region around

the longest horizontal line . It was called the value area, and had

significance as an area that the market was either within or out

side of. Its vertical range was important, in terms of whether it

was large or small in comparison to the average value area over

several day 's profiles . The change in value area size , i .e . , the

vertical range of the value area, showed either decreasing or in

creasing activity over the larger sample . It was used in a number

of ways for trading purposes in conjunction with other param

eters , but it was also used in a direct sense in that once the market

reentered a value area it would usually traverse to the opposite end .

initiating versus responsive activity: The tendency of traders at that time was to use support and resistance in putting on

their trades . This called for them to go against the dominance ,

which was not necessarily the best approach as markets began to change . For the more dynamic markets , classifying activity as

initiating versus responsive was a way to define objectively what

the condition of the market was in the trade set-up. Initiating

activity was when the trader went with the market, either above

the first standard deviation value area for a buy or below it for a

sell , and responsive activity was when the trader did the opposite. Naturally, a trade made under initiating activity should pro

duce more immediate results as the move should be already hap

pening , so to speak, and those taken in the responsive mode would

take longer to develop and generally had to be held longer.

parallel days: These were consecutive active days where the profiles were very similar looking , usually being normal varia

tion days . The second profile would be either slightly lower or slightly higher in range than the first . This profile configuration meant that the market was making a good effort in either con-


tinuation or in trying to reverse , and it pointed to the next day's

profile as being significant to what the market was going to do next in terms of direction . It was viewed as a set-up for a trade

opportunity, and the trader was alerted not to hesitate .

long term market activity chart: In the early days of Market

Profile, most traders thought it was a short term/day trade type of

program. It really wasn't, but I think the fact that it was an active screen-developing program caused people to look on it in that

manner. The long term market activity chart was a running sum

mary of range extensions , extremes , value areas , and TPO counts ,

that were noted as either initiating or responsive . It was divided

into buy and sell sides so that consistent activity would be con

spicuous on either side. It never really caught on, as it was cum

bersome and did not easily lend itself to graphic display with the

equipment available at the time . As is usual in cases like this, it

was actually very good, because its principle was fundamentally

sound in terms of portraying the collective dominance , which

corresponds to market background. It was especially so in view

of the dominance of floor liquidity prevalent at the time . In other

words , it gave us a plural instead of a singular reading: a reading

over a larger sample size of profiles. In fact, it is still a very good

idea in today 's markets . It was essentially a spreadsheet and, to

use it today, one should reconstitute it to include the more mod

em interpretations that you will see in later chapters . Also , there

are a lot of software programs that can do the same job easily today.

time information list: This grew out of traders ' need to re

solve the objective/subjective problem, and their desire to have lists of things to reference. I refer to it now as packaged objec

tivity -the orderliness of it made for a more comfortable feeling .

I cannot remember exactly what was included in it because as a

trader I never really liked using lists , nor did I really like presenting them in class . I did so only in the hope that it would help

people in their trading .

86 CHAPTER TEN

trade facilitation: This was recognition of what the market

was doing; it was a term used to describe the dominance dis

cussed earlier. The basic question was whether the market was

doing more business or less in a direction . This again was a lot

more subjective than objective , and called upon traders to bring

their understanding to a focus . li the market was doing more busi

ness , it would keep control away from liquidity; if less , then it

would slip back into liquidity, which was going to be horizontal

at best. Trade facilitation was a condition that directly impacted

whatever reason you had to trade . As a market discipline it tran

scended all other analysis by being closer to the top of the food

chain , so to speak: if no business was going on, or if business

was not increasing , then there wasn't much going for you . It was

also intuitive rather than exact. It was very similar to volume,

but was a subjective indicator that could measure the activity

that had moved liquidity to the background.

trapped money: This came later in our program, and was very

similar to the neutral day or non-trend day in meaning . The market would complete a small distribution with the first standard

deviation on the extreme, or a small-range trend day where it was moving directionally. This would occur near the bottom or

top of a longer-term range, and would signify a potential exhaus

tion phase in the market . When the market reversed following

the distribution in question, it would always stay above or below the starting point of the distribution in its subsequent activity,

thus providing an excellent reference point .

We can now return to the meaning of dominance . It corre

sponds to a concentrated force , capital flow, that overcomes the randomness of the market, thus giving it direction. As profile theory has developed, dominance has gone through three distinct

methods of expression . In the early profile days , when we classi

fied market action in terms of types of days, dominance meant directional activity overcoming the efficiency of the market; that

is, overcoming liquidity, which we might call the market's defense . Dominance had to prove itself beyond the boundaries of


efficiency. In the second phase of market profile , when we were combining profiles to form large bell curves, dominance repre

sented an offensive force that prevented efficiency from happen

ing , giving rise to the term "minus development" to describe a

period where inefficiency predominates in the market. And fi

nally, in the current database-oriented phase of market profile,

the measurement of dominance comes directly from dealing with

efficiency; that is, with any change in the vertical/horizontal re

lationship.

It is necessary to recognize dominance . What makes it diffi

cult, though , is that dominance has interruptions: it is there, it is

not there , then it is there again . I have termed the interruption

period a lull . In the early days of Market Profile, the background

of the trade always handled the lull period , by reassuring us that

longer-term direction, and hence the collective dominance, was

in our favor. Lulls always induced activity of an opposite nature

and needed to be looked upon with perspective . The perspective

or background we had at that time came from the type of day

classification system, which had its strength in having evolved

from the floor liquidity. For example, a normal variation day had

more dominance than a normal day, and the fact it could evolve

meant that the background would not just disappear but would at

least hold on. Trades were not made in isolation but as part of

this background. Background was , and remains , an essential part

of market discipline.

I have always tried to look outside our industry for examples, because for me it has always helped to clarify the situation. In

looking at dominance from my background of ranching/farming ,

I know that if you get careless when things are going well, you're

in for a long and painful process if conditions turn against you . The recent Quaker Oats/Snapple merger is a case in point. If Snapple's demand had increased rather than decreased, the amal

gamation of the two companies would have been easier to manage. In this case demand was the immediate dominance . The lull

was the period when attempts were made to improve demand,

88 CHAPTER TEN

and the background was stockholder patience with quarterly performance .

I have had many funny experiences relating to this . As a young

trader, whenever I started to recalculate my net worth, that mo

ment would be the high point for quite some time. Or, if I had a

very satisfactory position in something and I got the feeling that

my position was not big enough, that too signaled the end of the

move . Dominance was finished.

All this points out how difficult it is to keep things going when

they appear to be perfect . This is something you have to learn in

order to go forward. You have to proceed on the basis of a strong

foundation , and not try to build on the pinnacle of success , be

cause it has no base. It is the background that helps hold every

thing together: the outward control over dominance and its inter

ruptions . Change can be both frightening and a good opportu

nity, depending upon the circumstances . If you have built up

something over time , change tends to be a foe; if you're seeking

opportunity, change is the bulwark of it.

When Market Profile was introduced into the London mar

kets (the LIFFE exchange) in the late 1 980 's, it was at a very favorable time. Their liquidity was extremely high and was more

sustainable than ours here in the U.S . Many of the large trading

banks were members of the London Exchange and had floor trading operations , and so the floor liquidity had a good and active

financial base . The state of liquidity of the U.S . commodity markets had changed. Capital flow into markets had overwhelmed

the floor liquidity, causing chronological time and market time,

which had formerly been coordinated on the day timeframe, to diverge . Beginnings and endings no longer related to market open

ings or closes . This was a big change for Market Profile to handle. It was countered by moving to larger and different samples of

data -the second phase of Market Profile .

Time has brought the London and U.S . markets closer to parity. (The SFE in Australia is currently going through this same type of metamorphosis.) The time lapse in developmental change


between London and the U.S. helped define the change in the

U.S. markets. It did even more to verify that moving from the

first towards what would become the second phase of Market

Profile was the right thing to do. It helped enormously to validate

in a very direct way that the change I was in the midst of was

correct, by clarifying why the first phase of Market Profile worked.

When you're in the throes of change, you get all kinds of con

flicting thoughts, and the best thing that can happen is to find a

clarifying example that shows that the new direction is indeed

valid.

Prior to this change, we had already started to remove chrono

logical time from the day profiles, so, as the market changed, we

could change with it by removing chronological time altogether.

This was accomplished by splitting and merging market data into

smaller, larger, and different segments of market activity regard

less of their origin date. These provided development structures

and gave background control, promoting the move to market de

velopment time. (See Figures IV-l and IV-2 for an example of

this type of data rearrangement.) All the repercussions of this

were still not consciously understood by anyone, especially me.

Any data arrangement that retained Mike Boyle's entry system

was valid, and this was in fact carrying us correctly forward even

though we did not know it. As you will see in later chapters, the

data arrangement is a breakthrough that will change the very struc

ture of the industry for the better. The concept of data arrange

ment into segments that represented market structure began here,

and gave insight into the need to have a representative data base.

It was really the visual data arrangement that showed how the

market developed. Using the bell curve as a focus in this second

phase, our data arrangements took on a shape determined by where

the first standard deviation was located, which could be in one of

three places: on either extreme of the vertical data range, or in

the middle. We classified these profile structures as being either

a 3-1-3 (first standard deviation in the middle; see Fig. X-I, page

94, profile for Sept. 19 and Oct. 4) or 3-2-1 (first standard devia-

90 CHAPTER TEN

tion on an extreme; Fig. X-I, Sept. 30). At this juncture the per

ception also began to present itself that the only significant mov

ing part of the profile seemed to be the first standard deviation. It

took a long time for this to really register; the horizontal aspect

of building the first standard deviation seemed at the time to cor

respond to the dead period just before a vertical movement.

Market time was related to the complete development of the

profile into either type of bell-shaped structure, 3-2-1 or 3-1 -3.

In order to delineate market time, we soon learned that there were

four steps to the blueprint of development. Step 1 is the start of

the vertical movement, the laying down of the vertical range that

is to be developed. In this step the market establishes a series of

prices in one direction; it represents the most profitable trading

opportunity. Step 2 occurs when the market finds a price that

stops the vertical movement and begins to build the first standard

deviation. The third step occurs when the market begins to move

sideways, as it begins to develop around the area where it stopped

in the vertical range, and the first standard deviation begins to

emerge. Lastly, in Step 4, the market tries to bring the whole

structure to efficiency by moving the first standard deviation down

towards the middle of the range. We also noted that the first step

was vertical and the three remaining steps were mostly horizon

tal.

The most important result of arranging the data in this format

was that we could watch the four steps developing. This allowed

us to observe the cycle of change as really coming from the hori

zontal, the place of focus and increased control. Development

was horizontal, and studying it was more fruitful than working

with the unstable vertical. At the beginning we were looking for

vertical distributions coming after the completion of either struc

ture (3-2-1 or 3-1 -3), either of which would have ended with hori

zontal development. Such a vertical move was the start of a new

development that would become either a 3-1 -3 or 3-2-1 in its

tum.


When the market started out looking as if it were going to be

easy to classify, and then would suddenly change, short-circuit

ing the four step process by skipping a step or part of a step, our

trades were harder to control. I also observed that when a step

was missing because the market had skipped it, market direction

was dimensionally vertical, and for a sound reason, namely that

capital flow was causing a disruption or change in procedures. I

knew from experience that it took dominance to cause this re

newed vertical movement.

Dominance was synonymous with minus development, a new

concept that related to our work with the stages of market devel

opment. The term "minus development" came up one day in a

discussion with John Stafford. He repeated a "saying" from an

old trader: "It's what's not happening in the market that's impor

tant." We could deal with the interruptions in dominance (dis

cussed earlier) because we had the structure of the four-step pro

cess to fall back on during the lull. We knew where we were in

the four-step process, and I felt comfortable because we had the

same dominance and lull combination we had earlier, just deal

ing with it from a different perspective.

The old base for recognizing dominance was the floor liquid

ity from which dominance could be measured. The background

had now become the four steps of market development, together

with the potential existence of minus development which would

not allow the market to complete its cycle and reach efficiency.

This implied a change from a defensive, floor liquidity oriented,

view of dominance, to what we might call offensive dominance.

The way we measured it was through minus development and

the four steps: if we were missing a step or some part of a step,

we knew dominance was in place.

Again I must state that I was not consciously aware of all this

order and symmetry between both phases of Market Profile. I

just had a lot of peer support and my intuitive feelings to go on.

This allowed a continued movement to market disciplines of a

92 CHAPTER TEN

broader order. I was steadily progressing to a more abstract and

objective formulation from a more subjective and intuitive one.

This process also reinforced my receptive attitude toward

change. For instance, one of my dreams was to organize data

into large data masses, and be able to find a small change within

the large mass that would lead to far bigger things. Much to my

disappointment, I had never been able to do this. I think the source

of my failure was to always think about the large data mass as a

single unit. Instead of thinking of a large mass as I had been, I

changed to thinking of large in a different way, as a composite

large where the individual parts would be in place for me to see

specific change. Just finding this minor change of perspective

was instrumental in removing the blockage and allowing forward

movement. I like forward movement; it's necessary for all of us.

So I encourage change as a foundation of one's development.

As we leave this second part of Market Profile history, sev

eral things stand out as instrumental in taking us further. The

vertical alignment of the base of the bell curve gave it the format

to illustrate efficiency through its horizontal development. The

real role of the bell curve was the fact that you had to find the

first standard deviation, or at least some part of it. The relation

ship of the first standard deviation to the horizontal was very

meaningful, and provided insight into development time (the stage

of development that was under way). Reading the bell curve

through the first standard deviation gave direction to the thought

that this was probably the way to read the market. The similarity

of the first standard deviation to efficiency gave reason to ex

plore that relationship further.

Our software had developed to the point where I could try

some different data arrangements. I began to trade stocks actively,

and this brought even more focus, as it was far different from

commodities. Using the software, I came up with a way for the

computer to scan for efficiency, both for stocks and commodi

ties, and got some really profound results when running these

efficiency scans on live market data. I had no monetary goals for


these studies; it was just something to try while I viewed the

markets for trading. The scan results popped up where I thought

they would on my screen, and also where I did not think they

belonged. Both worked equally well, with the ones I thought to

be out of place being the best.

I knew I had done something very right, even though at the

time I didn't completely understand what I had done, or why it

worked. I could tell that the results were better than the normal

trading indicators that I was used to. I also knew that I had not

yet found the market's purpose, and that I would need to do that

in order to go further forward. Later, the impact of many differ

ent types of results provided great insight into the market's pur

pose. But most importantly, I gave myself time to learn more,

and I made the sacrifices called for in doing so. I paid no atten

tion to other people's standards Of success or failure. The growth

towards attainment of many goals during this period was very

large.

The evolution of the fundamentals of Market Profile has been

lost on the majority of users because most of the interest was in

using it to make trading decisions, rather than in understanding

the market. Development for purposes of understanding did in

fact continue, but the results were not widely disseminated. In

the past, for many who were and are interested, it was hard to

determine just exactly what the teachings were. The explanation

of the basic principles that we've already given, together with

the material that follows showing how I think they should be

applied, should go a long way towards clearing up the confusion.

For example, let's take a look at a very typical early display

of day profiles using Dec. Cocoa futures, starting on the 19th of

September 1996 (Figure X-I). The interpretations will be drawn

from both phases of earlier Market Profile theory, and are thus

subjective as to what the market is doing. We are going to be

helped along by the visual display alone.

First, look at what you'd like to do as a trader. Go through the

chart and identify the trades you might make in hindsight. I al-

94 CHAPTER TEN

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ways start out by visually reviewing groups of profiles that have

a similar orientation as to direction. I don't just look at the latest

profile, rather I look for an insight into the background. In this

case, the 19th through the 24th are moving sideways, the 25th

through the 27th are moving up, and the 1st through the 3rd are

moving down and then reversing. I look to find the first standard

deviations, and to compare what the market was trying to do. I

then look at their respective ranges. Look at the profiles from the

19th-24th. The first standard deviation is evident on all. It

starts in the middle on the 19th and ends in the middle on the

24th In between, its location is near the bottom of the range on

the higher day of the 20th. On the 23rd, the last time-period

spills sharply down, which has the effect of making the first stan

dard deviation for the day be in the middle of the range; prior to

that it was at the bottom of the vertical range. This is not a very

strong dominance. Notice the extremes on the 19th, 20th and 23rd,

as they are again indicators of a struggling direction. The quick

move late on the 23rd brings a balance to the laggard vertical that


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had been in place on the up days. Quick moves also bring things

to more of a focus, and you need to get more intent.

The activity on the 24th is bringing the opposing forces to

gether as the market is now balanced, ready for a new dominance

to emerge. This can easily be seen by putting all four profiles

together, giving a well-proportioned 3-1 -3 structure. By arrang

ing the data a little differently, one can see that the J time period

of the 23rd was indeed contained by this background (Figure X-

2). One could also note that the first standard deviation or value

area of the composite profile would correspond to the J period

range, and that J period traversed the value area; this is normal

for any such movement, as we explained earlier in the chapter.

By trading on the 25th one would at least be at the start of

something where either trade (buy or sell) could be evaluated

from the market. The next day was a trend day where the market

moved higher, and all was well if you bought, or sold and had

covered. The latter means you did a good job of exiting, which

really is a quite important trader function. The following day is

96 CHAPTER TEN

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typical of what takes place now, in that the dominance disap

peared and the lull was testing the longs' resolve. The 27th

brought early joy but again was cause for concern late.

Notice that the ranges are larger on the 25th-27th than on the

19th-24th, and it's hard to find the first standard deviation early

on the 25th and 26th -it became more obvious on the 26th and

27th. This is indicative of a good effort to move vertically, and

the market seems to be having the same difficulty as before, be

cause it's staying in the same trading range. The background of

dominance hasn't changed from the earlier set. Looking at the

data as a new composite, one can see an almost completed struc

ture of a 3-2-1 nature. (see Figure X-3). Collectively it is easier

to see the first standard deviation now. Subjectively, we must

weigh the background, and it is one where the vertical move

ment has had earlier difficulty. There is no evidence that that

situation has changed.

The real question will be whether or not the lull which is al

most certainly going to happen will be contained by the struc-


ture. It would be prudent to err on the side of caution. The 30th

confirms this. Notice that the 26th and the 27th are what have

been termed parallel days. (Figure X-I.) On the 27th the market

made a good effort to move higher, and really could not do much.

The following day is usually the clue, and it had the first standard

deviation in the low part of the range. Clearly the life of the

inefficiency in this example is not very robust. (This is a parallel

to the earlier Bond example discussed in Chapter IV). In making

an assessment of the market, one really cannot conclude that the

market is weak, but it's clear that it also can't rally much. A strong

dominance is missing. It would be best to liquidate if long.

Looking at the market from the 30th to the 4th sheds some

additional light on the subject. (Figure X-I.) The vertical ranges

of all the profiles are smaller than when the market tried to rally.

The first standard deviations are present except on the 3rd. That

profile was a trend day where the market worked slowly lower

and the range hardly expanded. Additionally, it was a potential

trapped money situation, as it was a market culmination near the

bottom of the trading range. The background of weakness to the

up side did not in this case translate into strength to the down

side, as there is no other evidence that supports it.

The 4th confirms this as it is opposite the high end of the 3rd.

As a composite (combination of the 3rd and 4th) the picture is

changed entirely, as it resembles a 3-2-1 up structure. (See Fig

ure X-3.) A great deal of change has taken place here, but it could

be expected if one has followed our analysis so far. If the market

were to spend less time in this low area on the 3rd and 4th than in

the high area (27th-30th), it would be a minus development situ

ation, and, given the background, this could be anticipated. Right

here is the crucial part of trading. The market is in good condi

tion to move higher and one has to act now. It is safe to buy and

it would be best get some type of activity on the 7th rather than

several days later, otherwise minus development would not be

there at this same price level.

98 CHAPTER TEN

This probably is the biggest characteristic of learning to be a

good trader-being able to see the opportunity early and not hav

ing to wait for it to become more developed. As we look at the

vertical on the 25th-30th and compare it to the 3rd-7th , it is very

clear that the former had more horizontal movement than the lat

ter. Therefore, the most logical trade would to be try to buy early

on the 7th and hope for the best. Remember that the market still

is going to have the same problem of vertical indifference unless

we see some evidence of change. Don't just focus on the fact

that you have a profit on the trade, focus on the situation that you

need: for the market to show a little more in the way of domi

nance to the upside .

You can now compare what we have done with the trades that

you could have made in hindsight. We probably did not do as

well, but we were in control of whatever we did.

I would suggest that those who like to use day profiles also try

to work with larger samples of study data as we did in the above

example. Most software has the ability to split and reorganize the

profiles beyond the day time frame. If you do this, then the same

simple display you've been using can take you further into un

derstanding the structure of the market. The basic 3-1 -3, 3-2-1

distributions will become apparent. Either or both of these pro

grams (working with day types and forming composites) will force

you to focus on the same thing in different ways. It will start you

toward more trading self reliance, because you will be making a

start on developing your market discipline from the market it

self.

There are just a few things to focus on as you work through

this program. The first standard deviation is the way to read the

market through the profiles, whether individual or composite. It

also defines efficiency as being present, and the sharp vertical

moves define non-efficiency. Be very alert for quick moves that

continue or reverse themselves. The range of the selected data

segments (day or composite) is important if the direction is clear.

Try to trade as early in the opportunity as possible by under-


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standing the background. It's sort of natural in trading to try to be

sure of the trade, but by the time you're sure it's often over.

This will provide the basis for your continued education, which

is mandatory for all of us. Its value is that it is not dependent

upon any participant but yourself, and the whole of activity III

the market.

I am now going to introduce some basic studies from our soft

ware that have the computer doing all the work. These studies

come from data that has been rearranged into a data base that is

completely free of chronological time. There is a great benefit to

this in that the workload is a lot smaller and traders can select

whatever condition suits their style or preference. In other words,

one can trade from only the best of situations.

In Figure X-4, I've overlaid the cocoa chart of Figure X-I

with a compression study that is derived from the new data ar

rangement. This study is very similar to the old value-area con

cept. It is flexible in that you can show any chosen percentage of

activity of any mass of data as a new mass within the old. The

100 CHAPTER TEN

scope of the study is shown by the large rectangle encasing the

range from the 1 9th through the 4th; the study area is shown by

the horizontal lines inside the large rectangle. In this instance, I

have determined where 93% of the data is, and thereby exposed

the extremes or third standard deviations in the total sample. They

are above or below the range of 1343-1384 enclosed by the hori

zontal lines. The profiles of the 25th through the 30th are then

defined as possible third standard deviations and are equivalent

to a profile extreme, and the same is true on the 3rd . The interior

of the compression serves as the container for the lull. Notice

minus development at the bottom of this area as compared to the

top.

Another overlay from the new database is the output of the

market's self-organizing system. This is depicted by the smaller

horizontal rectangles. These are areas where one can expect ver

tical movement away from this type of efficiency. Therefore,

they usually represent the start of something. One looks to have

the market stay above or below these areas. We intentionally used

a broader brush in the overlay in depicting the price as a heavy

horizontal block, as this brings more focus to what it really is: a

fair price area. In deciding what to do, one tries to focus on the

activity in and around the block or mark, as well as looking at the

background. The point is that since something vertical is going

to happen from this area, one is focusing on a potentially good

opportunity most of the time.

The first mark forms at the price of 1 364 at 9.00 0' clock on

the 20th. The market is moving 1 00% horizontally on the bal

ance of the day and again on the 23rd. You can see this in that

every time period (i.e. every letter) is used at the price of 1 363 on

the 20th and at 1 367 on the 23rd. At the same time, the market

was trying to move vertically higher. It's not a very strong situ

ation. One could sell it and look for the market to stay under it,

and if you did you would find the same condition in the horizon

tal occurring at the lower level on the 24th , again at the 1 363

level.


This shows that it is very hard to move vertically when the

market is experiencing 100% horizontalness. This is why one

needs a two-dimensional data base. If we were looking for price

movement, it would have been better to have experienced less

horizontal; a dynamic data base would have been more vertical.

If we had had 90% horizontal instead of 100%, the difference

would have translated into more vertical. Looking at the number

of time slots used versus the potential is an objective way of

measuring dominance. If you did sell on the 23rd under the out

put mark, you were not getting what you wanted, as the market

was staying efficient. In other words, our mark was at the begin

ning of efficiency, and efficiency just extended itself. The mar

ket is still going to move from this to a vertical. It started late on

the 24th and continued on the 25th.

The other mark on the chart, at 1375, occurred on the market's

open on the 1 s1. The market was already beginning to move

vertically down, so the zone of market efficiency was not ex

tended as it was in the first case, but cut off. The consensus or

fair value area (efficiency price level) then was the reference point

that the market used as a base from which to further develop the

vertical to the downside.

Although I am giving a subjective interpretation to you to help

explain this situation , all of this can be read by the computer, as

you will see in the next chapter. Note that the market output

overlay does not indicate anything on the 3rd, which subjectively

was a good opportunity. Notice that the compression does. This

is why one uses different types of studies all looking for the same

thing-market-created opportunities in the dynamic setting of

an objective data base.

The examples in this chapter show what can be done subjec

tively, as well as indicating the increase in understanding pos

sible by using an objective data base. I've continued to move in

the direction of increasing automation and objectivity, which gives

a real boost to my productivity.

102 CHAPTER TEN

CHAPTER ELEVEN

Looking to the Future--Data

Arrangement

From a historical viewpoint, any achievement of mine has been

entirely due to having the correct base from which to begin. The

market only spits out transactions; it is up to us to record them

correctly if in fact there is informational value in doing so. I have

never found any reference to the author of the current bar-chart

method of data recording, nor have I found any logical explana

tion for it. It just sort of arrived, and has been just sort of ac

cepted. Most people's focus to date has been more towards get

ting good trading results, with market prices fed into programs

that are thought capable of producing them. It is the program

results that are in control. But data arrangement is the real basis

of control; it is the first link to the market, and it requires active

direction in terms of organization. I've always arranged my own

data, rather than accepting the default.

The real key in objectifying the market is to find its purpose,

which is single. The benefit of such a discovery is less subjectiv

ity and more productivity. The data base plays a critical role in

this process of objectification. It is the basis of measurement, so

it needs to be able to represent market activity faithfully, without

distortion. It is the framework from which to ask questions about

data; it makes the data available as a fundamental resource.

103

104 CHAPTER ELEVEN

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I I " I[ tf&l I IE fG. IJ tiE fG, IJ

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t�V tI � : III n 1 I " ,,,r III t IE z. , U :""r tst zI fie t,E F

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lJ � z • E UG II J z fli I

• FG

" " " !i " , , ' " , , , , , , , , , , 1 1 1 1 1 1 1 1 1 1 1 1 1 7 1

Figure XI-I. Dec. Ten-Year Notes, 1996, Database "phonemes"

The ideal data base would be one where each data element, or

unit, would be one-dimensional and would be a measurement of

either verticalness or horizontalness. The units themselves would

start out with a neutral two-dimensional base, and, as soon as

there was any indication of being one-dimensional, they would

be completed. The units of the database would then be the small

est possible increments of change. The algorithm for unit forma

tion could not force completion, but must allow each unit com

plete freedom in its expression. Each unit then must be devel

oped in natural market time. All units would be dissimilar, as

they would define themselves. Some data units would have more

data than others. They would all have a dynamic nature which is

potentially of either dimension that would be formed from the

neutral setup. The definition of each unit would change in a com

parative way as successive units were added. This would allow

for relativity in terms of the background, which is very important

when collecting data sequences for trader viewing and analysis.

In essence, the algorithm would be identifying the basic elements,

LOOKING TO THE FUTURE--DATA ARRANGEMENT 105

the phonemes, that make up the language of the market. Any and

all studies in the data base would then be giving a different view

of the same underlying process. Any further data arrangement

would have a sound basis on which to build.

The practical side of this list of requirements as it relates to

our software is that we have had the data base in place for several

years, but we did not have the market figured out as to its pur

pose. (Figure XI-1 shows a typical set of basic units, using the

Dec. Ten-Year Notes contract for 1996.) I made a lot of progress

through doing different data arrangements and efficiency scans

that started producing indications at exactly the points where we

were making subjective trading decisions, as in the earlier cocoa

example. I would be talking to some friend who was a good

trader, and he would say that he really liked bonds, and had bought

some. So I'd bring up bonds on the screen, and more often than

not there would be a scan or data arrangement output on the screen

at the same level. I was experiencing the same thing myself; wher

ever I wanted to make a subjective trade, it would also be indi

cated on the screen objectively.

I started looking at a screen with just the data base and no

studies on it, going through and determining in hindsight what

was the best trade. I would then run my programs, and the indi

cations would be very close to the artificial level on the hindsight

trades. But I was more interested in finding the market's purpose

than in finding things that worked as far as trading was con

cerned - thus the chapter title. All this went on for about three

years before the insights I related in the first chapter dawned on

me. In essence, market discipline is really efficiency in action,

and finding efficiency is indeed the market's purpose. It is very

difficult to make money when the market is efficient, so the less

efficiency there is, the more the opportunity. With my computer

studies, dynamic efficiency was being captured and measured.

This was the critical information our data base was producing,

and we only needed to understand it in this light. We had some

how managed to put the system together as an outgrowth of a

106 CHAPTER ELEVEN

'111 '" '" , .. ... ... ...

� II�!IJ!!'

'U "

'" "

III 'U ... • 11 '" '"

.!!? 1:::::1::::111111111:::::111111111111:::111111::1:::::111111111111111111111111111111111111111111111111111;

Figure XI-2. Dec. Silver, 1996

solid base of practical experience. The whole development pro

cess was completely opposite to the current back-testing mania.

We were trying to find something, not just anything.

Having the answer emerge from the data itself is a basic or

ganic way to approach analysis with any program where there is

no theoretical basis to work from. By having the right data orga

nization, working with it, and making it the central focus, one

would logically be in step with the market. It is what the market

itself is referencing. The market has never ordained a data base

or arrangement other than successive quotations. It is not pro

ducing a one dimensional representation, nor is it producing trend

lines, moving averages etc., or referencing them. These are out

side the market, at least once removed, and are subjective. They

do not provide a control that comes from within the market, and

therefore have to be supplemented with further financial con

trols. What the market is producing is some degree of efficiency,

and it is this information that needs to be found.


� mltj" M"r" !!44-0;#!r:=ilU:;;:.DI;iWIP&M.-

wl,.'i .c.ontrllct fage o.ispilly lillviglllte ::ihnly Window Utility feed SCAn Help

Figure XI-3. Dec. British Pound, 1996

The last step in getting control over the market is to under

stand its condition. We talked about dimensionality in an earlier

chapter, and said that the way to measure the market was through

its dimensions. Based on the argument of this book, its dimen

sions thus have to be measuring efficiency. Dimensional mea

surements reveal the present state of the market with regard to

efficiency, and therefore a change in dimensionality is in fact a

change in the state of this primitive, basic process. We can mea

sure dimensionality by monitoring the vertical/horizontal rela

tionship in an appropriate data base. The trades that seem to work

best always come from the best background situations. The back

ground is composed of the degree of efficiency in the data mass

that is under consideration. Testing the market for efficiency

characteristics could eliminate a lot of wasted time and money.

Let's make these ideas more concrete by looking at some ac

tual examples using the modern Market Profile database. Our

examples involve the December British Pound, Canadian Dollar,

and Silver contracts for 1996; the relevant charts are given in

108 CHAPTER ELEVEN

!' "!iii'"." #4j-=w=:a."a ....... -�DIlIJ'l!'ct �e 0.1. lay Navigate ,S.tudy Window lltIlity feed SCAn Udp

Figure XI -4. Dec. Canadian Dollar # 1, 1996

Fi gures XI -2 through XI -4. (In these charts, the basic database

units, which were shown as small profile fragments in Figure

XI-I, are portrayed as bars for compactness. The database pro

cessor identifies a significant control price for each bar; it's shown

as a small dark rectangle on the bar.)

In all three examples, the data representation in the foreground

is practically identical. Each chart shows two data outputs from

the market's self-organizing system (shown as approximately

square-shaped open rectangles) at roughly equal prices, which is

indicative of extended efficiency, followed by a scan indicator

(large black rectangle) marking a short-term inefficiency to the

up side. If only the foreground is considered, all three look like

potential rally situations, and trades in all three commodities

would be made and managed in the same manner going forward.

If you had the ability to analyze the background condition of

the market, you would see that while silver was a foreground

opportunity, it was different from the other two. Running a back

ground efficiency scan on all three charts (shown by narrow open


"- iill!§!li.'b ��l=g=Er.;;r·;-,-� .contract fage Display tfavlsate Study Window 1,!tIlity feed SCAn lielp

:-r.,,';,1,

Figure XI-So Dec. Canadian Dollar #2,1996

rectangles), we see a lot more hits on silver, which indicates a

more efficient condition, presenting more of a trading rather than

a trending atmosphere. The Canadian dollar and British pound

had a more inefficient background, and this, coupled with the

inefficient foreground, made the opportunities more of a go-with

and stay-with trading opportunity. In the silver trade, the near

term inefficiency would soon be absorbed by the background; in

the others, it would tend to make the background more ineffi

cient.

If we look back just a little farther in the data on the Canadian

dollar contract (Figure XI-5), we can again see the same set-up,

but one that has more hits of the efficiency scan in the back

ground. As the market trades forward in this instance, the effi

ciency scans did not materialize, indicating that the background

was not absorbing the foreground inefficiency. The market was

in fact separating itself from the prior condition. In the earlier

Canadian dollar and British Pound trades, and in this chart, the

life of the inefficiencies was sustained - a favorable condition

110 CHAPTER ELEVEN

for the trader to capitalize on from an objective point of view. In the silver trade, the objective near term condition would have

had to prove itself by not producing scan hits; since scan hits

continued to occur, the trader would know to exit the trade before a loss was incurred.

With all this information available in the data base, it is only

necessary to develop varied formats that will present it to us in a

readable way. They do not have to be the optimal solution, but the process needs to get started. With any new format, one first

has to explore the outer limits of possibility. What are the ways the market can change? Fortunately, the conditions that are pos

sible in the dimensionality of the market are limited. It can have vertical growth without any horizontal, which would be characteristic of an inefficient situation; vertical and horizontal growth taking place together, which would be characteristic of an actively efficient background where the market would have a tendency to rally off lows and break off highs, while keeping to a traditional trading range, and where the inefficiencies are absorbed into this active background; horizontal growth without any vertical, which would be characteristic of a developing efficiency that is closer to completion, where one would eventually find that the first bit of change occurring in it triggers the efficiency output

itself; and lastly no growth in either dimension, which represents a very dead situation in which efficiency would be present, and a

condition that could not absorb any near-term inefficiency but rather would be influenced by it.

One can see that there is scope within these four categories for a spectrum of relativity between horizontal and vertical. For

instance, we might have a numerical vertical reading in succession of 21 , 22, 23, 24 ticks in a range, and a horizontal numerical reading of 10, which is unchanging. In another instance, the vertical sequence could be the same while the horizontal might be 26. In the first example the vertical is leading, and in the second

it's about on par with the horizontal, even with the horizontal being locked. This measurement is taking place within the mar-


ket and is measuring efficiency objectively in natural market expressiveness. The comparison then is going to be quite relative even though both are non-efficient, being engaged in one-dimensional vertical movement.

We've talked about how the background of the market has

changed since the early days of Market Profile. The change in

the markets has also shown up in other related areas, as we have

seen in earlier chapters. Liquidity is now quite weak, and also

quite variable. Because of weak liquidity, and because dominance is less concentrated and has a more diversified meaning

today, dominance has become more or less destandardized. The lack of liquidity and change in dominance create a need for redefining trading information compared to what was done in the past.

Now that we understand markets better, reading the degree of efficiency and the change therefrom is the new and future way to go. Efficiency can now be used the way liquidity and dominance

once were, and liquidity and dominance can be removed from their prior role of being a superimposed structure within the mar

ket. At one time they mirrored the efficiency concept, much as

my trade facilitation idea did, but, because they were derivative rather than fundamental, they ceased to reflect the situation accurately when the underlying conditions changed. The background

is no longer a given, but is quite variable, and measuring dimensionality is a means of understanding it. Dimensionality would now express efficiency, and provide a contrast between foreground and background, making market analysis more direct; it should therefore be the new market measurement.

It is important to note that the background and foreground are now being defined objectively in the same terms, using different studies, those terms being the degree of efficiency. To gain con

trol, a trader can express a trade opportunity in these terms, and change can then be directly related to the opportunity. An example of the use of background in trading could be a situation

where the market had been moving vertically lower without any horizontal increase, changing to one where both vertical and hori-

112 CHAPTER ELEVEN

zontal were actively involved. Seeing the change, you decided to buy, and were fortunate enough to have the market move ver

tically up. The overall condition is that the market is moving down in a controlled way, with both dimensions active. The foreground

is doing the opposite: moving up with both dimensions active.

Now you face a lull where the market has begun to move only horizontally in the foreground. There has been a slight change in the background sample; it is still moving down, with both di

mensions active. In this case one could not face very much deterioration in the new dominance-otherwise, the dominance would

be absorbed by the background. Focus, then, would be on the near term activity being dominant enough to gain and keep con

trol. Another example could have the market's background as effi

cient, with no dimensional movement. The market moves vertically up in the foreground, with both vertical and horizontal dimensions active, the same as in the first example. It then shifts into a lull and begins to move just horizontally in the near term. The background now shows a changed condition, in that having been neutral or efficient, the more recent activity has changed it

to where it is now moving both vertically and horizontally higher.

This would be a positive change in the direction of the trade, so the near term situation is not as demanding as in the first ex

ample. Therefore the strategy would be different; you would almost have a free peek at the market, which will be either continuing the dominance or moving sideways, since a faltering in the short-term dominance would at worst throw the market back into efficiency at the higher price level.

At the end of Chapter V I we said, "When we combine the free

expression of dimensionality with the consensus output on an objective data screen, it's only then that the market defines itself." In our software we have created a spreadsheet that does just that. We call it our data base controller. Its function, among other things, is to give an objective reading on the market's dimensions and other objective conditions related to market disci-


plines. Using the controller is similar to being in the pit, where one can see a change in conditions taking place over and above just a series of price changes. It is not price change, but market change, that is being recorded. The data base controller also de

picts the near-term inefficiencies as they relate to the background, either being absorbed into it or in effect influencing or changing

the background. More importantly, it objectively defines the lull, which is an activity that is usually counter to the direction of

dominance. The data base controller is similar in principle to the

old long-term market activity chart, and, as we add more func

tionality to it, it will eventually fulfill the goal of making the market's inner workings clear.

To best get a handle on dimensionality, we have tracked infor

mation for two time frames: a slowed-average type program for increased stability in reading the background, and an actual ver

tical/horizontal development from the last market overlay of output (the "Page 2" mark) for foreground information. Change in dimensionality defines the dominance in the near term. The background condition is defined with a broader reading of the same

kind. The key here is the word "define." We have not placed faith

in a power big enough to overpower something else, as we did in the past with liquidity or market structure. Whatever is there is there, whether large or small; it's there to be measured in the whole of the market.

The first two data base controller examples illustrate the more

common horizontal efficiencies found in the market. We have found it extremely exiting to work with uncommon efficiencies, which are fragments in the vertical, as well, but the software to deal with these is still under development. Our third example gives a look at this kind of market situation.

Table XI -1 shows a typical section of data base controller output.Let's consider the overall format first. As the time column suggests, the data is sampled every hour and a half. The columns labeled "Bands" and "B-Horz" characterize the background in terms of numerical studies run by the software. Bold numbers

114 CHAPTER ELEVEN

Contract: FVZ6 Samples: 249 %Chg: 1.95% Date Time Price Bands B-Horz Holds Page2 Vert-2 Horz-2

10/23/96 15:00 106130 1 Dn 4 70 13

10/23/96 19:30 106130 2 Dn 4 70 13

10/24/96 3:00 106130 2 Dn 5 70 13

10/24/96 5:00 106130 2 Dn 7 70 13

10/24/96 7:30 106110 3 Dn 9 70 14

10/24/96 9:00 106100 4 Dn 10 70 15

10/24/96 10:30 106090 4 Dn 10 70 18

10/24/96 12:00 106110 5 Dn 10 70 19

10/24/96 13:30 106130 5 Dn 13 106150 10 2

10/24/96 16:00 106120 6 Dn 13 12 4

10/25/96 4:30 106130 6 Dn 14 18 4

10/25/96 7:00 106110 7 Dn 14 18 5

10/25/96 8:30 106120 7 Do 17 52 8

10/25/96 10:00 106170 8 Dn 18 68 9

10/25/96 11 :30 106160 8 Dn 18 68 9

10/25/96 13:00 106160 8 Dn 18 68 9

10/27/96 20:00 106170 8 Dn 18 68 10

10/28/96 8:00 106170 8 Dn 18 68 12

10/28/96 9:30 106160 8 Dn 18 68 15

10/28/96 11 :00 106150 8 Dn 18 68 16

10/28/96 12:30 106140 8 Dn 18 68 16

10/28/96 14:00 106140 8 Dn 18 68 16

10/28/96 16:30 106140 Up 2 68 16

10/29/96 8:30 106240 Up 3 94 17

10/29/96 10:00 107000 2 Up 3 128 17

10/29/96 11 :30 107010 3 Up 6 128 17

10/29/96 13:00 107030 4 Up 7 138 17

10/29/96 14:30 107050 4 Up 7 142 17 10/29/96 16:00 107050 6 Up 7 148 17 10/29/96 18:00 107050 7 Up 7 148 17 10/30/96 1 :30 107050 9 Up 7 148 17 10/30/96 3:30 107060 10 Up 8 148 17

10/30/96 5:30 107080 12 Up 8 158 17 10/30/96 8:20 107070 13 Up 8 178 17 10/30/96 9:30 107030 14 Up 10 178 17 10/30/96 11 :00 107040 15 Up 11 178 17 10/30/96 12:30 107020 17 Up 11 178 17

Table XI-I. Database Controller Output, Dec. Five-Year Note, 1996


indicate a downward orientation of the background. The columns at the far right, "Vert-2" and "Horz-2", describe the foreground in

terms of the relationship between vertical and horizontal development. Bold numbers in these columns indicate a downward

orientation of the foreground in relationship to the "Page 2" con

sensus price area,the output of the self-organizing system, shown

in its own column near the middle of the page, When a number

appears in the Page 2 column (as 1 061 50 did at 1 3:30 on 1 0/24), it causes the two right side foreground columns to begin their

calculations anew, thereby giving us quicker and more current

information. It does not affect the calculations of the left-most columns.

In looking for general change in conditions, it is best to group the lines of change into loosely defined units of group activity for purposes of analysis, rather than using each individual line.

For more specific reading, one does focus on an individual line

in relation to this general reading. Market change is much smoother and less erratic when read in this manner. For our pur

pose we will look at both columns in loosely defined groups of four or more in relation to the specific change line.

Our first specific example is that of the five year note which is traded at the CBOT. We'll start by reviewing how the data changes

in a more general sense. In looking at the whole page, notice that the right-most set of vertical columns first change direction on the 25th just shortly after the Page 2 mark. Going to the top of this column, notice that the numerical value of the vertical, 70, is not changing in front of the Page 2 mark, while the horizontal is at first locked at 1 3 but then begins to grow. We get a new start, which shows some continuation to the downside on the first five

units after the Page 2 mark.

Now let's look at the slower-developing column on the left. Looking from the top down to the same point on the 25th, we can see that both columns are growing, which is an indication of an active two-dimensional market to the downside. Comparing the numerical values in the two background columns, the horizontal

116 CHAPTER ELEVEN

is more than twice the size of the vertical, so on a relative basis the market is not that weak. The conclusion is that one can usually buy breaks or sell rallies in this type of environment.

If we now look to the 10:00 line on the 25th, and look at the

Page 2 column, we can see that a sudden, quick, and dramatic

change has taken place that causes a directional shift from down to up. You can tell this by the amount of numerical change. The

number in the last down line was 52, and the number in the up

line has changed to 68. This represents a non-efficient event that may be dominant enough to change the current situation.

The following ten listings show no more vertical change, but

increasing growth of the horizontal, as the market adjusts to the change. Notice how the activity in the slower background col

umn decreases until there is no vertical or horizontal movementa dead state of efficiency. Both of its dimensions stay locked at 8-1 8 for nine successive units, which represent the effect that the faster Page 2 column changing has had upon it.

Notice further that the prices in the price update column stayed relatively calm for the period within in this same zone. Clearly there is not a background condition that has to be overcome.

(Background does have a tendency to absorb the foreground inefficiencies.) The issue is whether the upside inefficiency is going have a life. We can see that it does, as in the foreground vertical column it begins to increase vertically, and the horizon

tal locks at 1 7 while the vertical continues to grow. Activity of this nature is one-dimensional vertical, a very strong situation for the trader. It also creates a favorable background as we leave the example-one where it is growing both vertically and horizontally, and where the verticallhorizontal relationship has the vertical leading (being greater than the horizontal), in contrast to the earlier relationship in the background where the market was moving down with the horizontal roughly double the vertical.

Our next example is in the D-mark, which is traded at the CME. Notice that the foreground vertical column is up ahead of the Page 2 mark, and that initially the background vertical (the


Contract: DMZ6 Samples 457 %Chg: 0.45% Date Time Price Bands B-Horz Holds Page2 Vert-2 Horz-2

11/06/96 13:30 6605 14 Dn 13 53 12

11106/96 15:00 6605 16 Dn 13 53 12

11106/96 17:30 6613 17 Dn 13 53 12

11/06/96 19:30 6645 17 Dn 13 94 12

11/06/96 21:00 6646 IS Dn 13 94 12

11106/96 22:30 6665 2 Up 3 114 12

11107/96 0:00 6664 2 Up 6 114 12

11107/96 1:30 6648 4 Up 7 114 12

11107/96 3:00 6652 4 Up 7 114 12

11107/96 4:30 6644 5 Up 8 114 12

11/07/96 6:00 6649 6 Up 9 114 13

11/07/96 7:30 6646 6 Up 12 114 15

11/07/96 9:00 6638 7 Up 13 114 17

11/07/96 10:30 6648 8 Up 15 114 19

11107/96 12:00 6650 9 Up 18 114 22

11107/96 13:30 6629 10 Up 18 6623 14 1

11107/96 15 :00 6629 11 Up 18 16 3

11/07/96 17 :30 6628 13 Up 18 16 5

11107/96 19:30 6624 13 Up 18 16 7

11107/96 21 :00 6621 13 Up 18 16 7

11107/96 23:00 6623 15 Up 18 16 8

11108/96 1 :30 6628 16 Up 18 16 9

11/08/9 3:30 6637 18 Up 18 23 10

11108/96 5:00 6638 19 Up 18 23 10

11108/96 7:00 6637 21 Up 18 23 10

11108/96 8:30 6632 22 Up 18 23 12

11/08/96 10:00 6656 24 Up 21 43 12

11108/96 11: 30 6657 25 Up 21 50 12

11108/96 13:00 6664 26 Up 21 50 12

11110/96 17:30 6666 28 Up 21 50 12

11110/96 19:00 6665 29 Up 21 52 12

11110/96 20:30 6670 30Up 21 52 12

1111 0/96 22:00 6672 31 Up 21 55 12

11110/96 23:30 6671 33 Up 21 55 12

11111/96 1:00 6666 33 Up 21 55 12

11111196 2:30 6666 34 Up 21 55 13

11111/96 4:00 6662 34 Up 21 55 13

Table XI-2. Database Controller Output, Dec. Deutschmark, 1996

118 CHAPTER ELEVEN

left hand columns) is down for the first five listings before changing to being up. The down background is relatively strong, showing increases in the vertical while the horizontal is locked for the

first five listings. The foreground is extremely strong, and is not being absorbed by the background. You can see the numbers in

creasing in the vertical foreground from 53 to 1 1 4 without any

horizontal movement. It almost doubles its vertical base. It changes the background, which was moving vertically down, to

where it is vertically up, with both dimensions now active. Notice that the vertical and the horizontal in the background were

about equal. Thus, the ability of the sharp foreground move to change the background.

The foreground, in contrast, is making a very strong showing

to the upside with good vertical change, with the horizontal being locked from the same sample size. The verticallhorizontal imbalance here increases from four times larger to over six in favor of the vertical. The foreground has been and is clearly in

control and dominant. One must remember that dominance has interruptions, and that usually one faces a deterioration or test that serves as a basis for renewed vigor if it proves only to be an interruption. Such a lull usually starts after having a period of strength; the vertical refuses to grow for a period, and then it starts a move to the downside. We can clearly see this in the foreground column, where we had ten successive unchanging vertical updates at 1 14 with the horizontal locked at 12, then growing to 22 just before we got a new Page 2 mark at 6623. The ten successive unchanging vertical updates represent the beginning of the lull.

The Page 2 mark indicates the sample's efficiency, and that

usually means that a vertical move will follow. Subsequent to this mark, the market changed to down, continuing to expand the lull. The background column opposite this in the same time period was moving in a one dimensional manner, in that the vertical was growing upwards with the horizontal locked at 1 8. The


background is in control here, and can absorb some counter activity that can take place in the lull.

The down period in the foreground includes six listings where the vertical stays locked at 16 and the horizontal grows through

out. This illustrates that the market again has found efficiency in the foreground (in addition to the Page 2 mark) and the lull is

about over. The background has absorbed the counter activity, which was not much more than a stall.

The next line shows that the up vertical dominance is return

ing on the 8th in the foreground, so the inefficiency of the background will be enhanced, thus giving it more life and the trader more opportunity. The price at this change is 6637, which is

above the Page 2 output mark; it will serve as the vertical base for further development.

The focus for the trader will now shift to the foreground, as it

is its continued progression that is important for the trade. The vertical is actively growing, with the horizontal giving a mostly locked performance. The background responds to this by continuing to show good vertical direction, locking at 21 in the hori

zontal after only one horizontal change, which occurred at 18. Note that after the Page 2 mark at 6623 the vertical/horizontal

relationship in the foreground moves to four times the horizontal, and that of the background changes from being a little less than half the horizontal to being more than one and one half times

greater. As a trader, then, you'd be continuing to watch for the interruption of this new surge of dominance and the onset of the inevitable lull.

Our last example deals with finding some of the more uncommon efficiencies in the market. Most of those we have found and worked with to date have been the more common varieties that come in the more horizontal periods of price movement. We have found that efficiencies can be fragmented and found in the more vertical periods, and they are very good at referencing abrupt changes or continuation in the vertical movement. We've come

up with two ways to illustrate this, and the software to automate

120 CHAPTER ELEVEN

Contract: TYZ6 Samples 88 %Chg: 1.03%

Date Time Price Bands B-Horz Holds Page2 Vert-2 Horz-2

11/05/96 22:00 11009 45 Up 34 30 20

11105196 23:30 11012 45 Up 34 32 20

11106/96 1:00 11013 47 Up 34 34 20

11/06/96 2:30 1 l01O 47 Up 34 34 20

11106/96 5:00 11009 48 Up 34 34 20

11106/96 7:30 11002 48 Up 34 34 20

11/06/96 9:00 11000 48 Up 34 34 20

11/06/96 10:30 11004 49 Up 34 34 20

11106196 12:00 11003 49 Up 34 34 20

11/06/96 13:30 10931 49 Up 34 34 20

11106/96 15: 30 11000 50 Up 34 34 22

11106/96 18:00 10931 50 Up 34 34 24

11/06/96 19:30 10925 51 Up 34 10929 3 1

11106/96 22:30 10923 51 Up 35 12 2

11/07/96 0:00 10922 51 Up 35 12 3

11/07/96 1:30 10925 51 Up 35 12 5

11/07/96 3:00 10926 52 Up 35 12 6

11/07/96 4:30 10923 52 Up 35 12 9

11/07/96 7:30 10922 52 Up 35 12 11

11107196 9:00 10924 52 Up 35 12 14

11107/96 10:30 10922 52 Up 36 12 17

11/07/96 12:30 10931 52 Up 38 17 17

11107/96 14:00 11007 52 Up 38 25 17

11107/96 15:30 1 l01O 52 Up 38 27 17

11 107/96 18 :00 11010 53 Up 38 28 17

11107/96 19:30 11010 53 Up 38 28 17

Table XI-3. Database Controller Output, Dec. Ten-Year Note, 1996

it is currently under development. We'll analyze one of these manually. There is a little more to it than what we are going to set out here; however, we'll be able to demonstrate what we're after.

The procedures within the data base controller allow us to set up a way to isolate fragmented efficiency in the vertical. Look-ing at the data base controller display in Table XI-3 (the Ten-Year Notes), consider the foreground columns (the two right-most columns). A change in the horizontal on the 7th by three (from 11 to 14 ) comes just after the low price that occurred at the 7: 30


listing of 1 0922 on the 7th. Another such change occurs in the following sequence at the 1 0:30 listing at the price of 10922. Notice that the vertical foreground then starts increasing, and the horizontal remains locked, giving a one dimensional vertical opportunity that is occurring near the low of the previous move.

The price low on the display of the data base controller is 1 0922; however, since the change listings are predetermined in the setup,

I want to point out that the actual price low for this study zone

was 10916.

In all of the above examples, we have shown you a more traditional exercise, in that knowledge, skill, and work were all applied in a very laborious, time-consuming way. Applying this

methodology to the markets would limit one's productivity in a

physical way. It is important to note that it is not at all necessary to go through this type of exercise with each trade you make in the future. It is only necessary to provide the computer with the knowledge-based requirements of trade opportunities, and it will deliver the set-up and monitor the conditions for you. An example of this sort of screening in a business context could be that an ore producer would like to open a new mine, one that had a certain ore content per ton that could be profitably developed.

Mine properties then would be screened until the requirements were met, and those selected would begin operations.

The varied components in the markets today give us a collec

tive dominance, where a great many traders are not really desirous of directional movement; for example, in structured trades

that are looking elsewhere for the payoff. In this environment, it's important to be able to find directional movement as well as measure it against a background, rather than just considering it in and of itself. Early on in my trading career we could determine

who was right or wrong, as the traders who bought or sold were desirous of opposite things. Not so today.

To deal with this situation, we can ask our data base for a background of such and such with a foreground of some particular nature; for example, all the commodities that are at least 75%

122 CHAPTER ELEVEN

efficient on the background and 60% efficient in the near term, and that have just traversed a market output (Page 2 mark). To

give another example from business, we can be like a corpora

tion that wants to buy smaller companies. The CEO tells the staff that the corporation's interest will be limited to companies with a

certain amount of gross in industries that have exhibited x amount

of growth during the past three years . Once they buy any company, it has to move up to at least being number two within a

certain amount of time, or they dump it. Now traders can specify their trade parameters and justify their activity the same way.

Using an objective data base in today's computer world al

lows traders to expand far beyond their subjective self. The ad

vantage goes to a machine-readable data base versus one that requires a visual or physical presence. There are lots of for-in

stances, and I don't want to overdo it, but one example would be where you sense that there is an opportunity in cocoa and the move materializes over a period of six to nine months, producing a ten thousand dollar move per contract. The market moved as you expected and you made about 60% of that as per your contract size. The results are very good; however, having identified the opportunity, instead of just one entity (you) handling a trade, it is entirely possible to have several trading programs of differ

ent natures trading into the same opportunity. Let's just assume you had five programs and they each made three thousand dollars per contract. You have made fifteen thousand dollars out of a ten thousand dollar opportunity -a great improvement over a very excellent one-entity program.

Or say you are interested in stocks, and you have several thousand in your data base that you have been following. You can ask for all those satisfying certain background/foreground conditions, route them to various computers according to their characteristics, each of which has a trading program that fits its chosen scenario, and make them meet certain conditions in order to stay with the trade. All the programs of one type would then be competing versus the same standard, and those with inferior develop-


mental qualities could be watched more intently or just eliminated.

In closing this chapter I'd like to relate another one of my

ranching experiences. The horse stock we had at the ranch always came from a person or family that had a horse that they boarded with us. As their interest waned and the feed bill rose,

usually they traded the horse for the bill. I have spent many a hot,

dusty summer day on horses that just were not suited for the pur

pose, and I know what it feels like. Using an outdated or inferior

trading approach is as bad as using a family pet when a work

horse is required. Since that time, I've always made the investment in productivity whenever it's reasonable, and I still recom

mend the same.

124 CHAPTER ELEVEN

CHAPTER TWELVE

Price ... The Market Messenger

Up to this point, throughout most of the discussion, there have been very few references to price. The reference instead was to

market activity, its free expression, its output, its dimensions, and its disciplines. Price is the medium chosen to illustrate change, and by its very nature is one-dimensional vertical, which tends to create a reactive atmosphere. Long thought of as a controlling element, price has been treated as all encompassing, without be

ing defined. Price offers only a limited view, as it changes only in relationship to itself, and the depth of information it conveys

is highly varied. It intensifies the one-dimensional approach that all involved in markets seem to take. To most, it's the only choice, and it has never been questioned as the matrix of activity.

For people with this view, price has evolved into being the market data base. It organizes background and illustrates change

in what appears to be an objective setting. In this way, it seemingly provides a medium through which introduced trading disciplines indicate opportunity, and these, coupled with financial discipline, offer a major means of control. Price change is equated to market conditions, to being right or wrong financially, and a host of other things. The fact that it is always changing makes it a hard message to read or interpret.

125

126 CHAPTER TWELVE

As a message, it is ill-suited for the roles it has been used in. Its value in this total background is highly subjective, due to the

amount of interpretation called for. A price change related to itself has a very limited objective information content, especially

when we're interested in market expression and condition. Used

as it has been, it substitutes for market objectivity by defining the related but external trader and financial disciplines to augment

each other, creating two dimensions. It has aspired to objectivity as a goal, when in fact the whole process is substantially subjec

tive. In reality, market conditions and change are defined by the

market's dimensional makeup. Price data needs to be directly related to this to be in step with the proper representation. As the

medium of expression, price will always change, but it is not the expression itself; that is the misinterpretation here. When price is used as a message, rather than being regarded as a messenger, it creates the need for strong subjective skills in interpreting what most consider to be objective output.

CHAPTER 13

Where Do We Go From Here?

There are going to be two conclusions reached as a result of this book-yours and mine. I hope that I've presented a back

ground that has been beneficial in helping you come to your own conclusions as a trader. I firmly believe that a trader's development does not come from theory, but from practice and observa

tion. As knowledge and experience grow, one moves toward simplicity. If one is fortunate enough to have started on the right path, coming to a final focus opens up opportunity as never before.

The bottom line is that Market Profile best serves as a data base. As such, it fills a basic need that is not currently being met. It provides a dynamic two-dimensional method of data entry and collection that gives the market freedom to objectively display itself. It gives one the ability to learn from observation, and thus provides the necessary foundation for a trader's development.

The path to the future has been laid out. With the cost of information and computing equipment within reach of the average person, and with the availability of computerized market analysis algorithms, the burden of following the market falls on the machine rather than the individual, making trading practical for a vastly increased population, in a way that would have been impossible ten years ago.

127

128 CHAPTER THIRTEEN

I also think there's a path to the future for our industry. I feel that at this juncture, drawing on the experience I've gained over 35 years, I can see areas of change in the industry that are as important to it as the changes I have been through were to me as

an individual.

With all the money and talent that has been put into this in

dustry, plus the growth in the power of the computer over the past few years, it would seem to be a small accomplishment rather than a large one only to have distilled the trading process down essentially to arbitrage, i.e. relationships between various products, rather than the contrast of things within themselves. A great deal more has been done by some individuals and companies in a subjective way, which I think supports the idea that more can be done objectively.

The shortfall is due to the unfortunate representations of mar

ket data being used, to the representation of opportunity as one dimensional, and to lots of faulty ideas and concepts about markets in general; to the "it's not possible," "one can't do it," and, even more importantly, to the lack of openness to new ways of doing things. This even extends to trying to find ideas or new directions. In recent times there have been no indirect benefits to the industry like those that formerly came from the large compa

nies or exchanges doing new things. Sort of reminds me of an

old feeling: it's quiet out there. That is the condition in which one does not know what type of problem one faces.

I feel that as an industry we have become a great deal more

cynical internally, and it is very hard to shake this overall effect. It's rather ironic that we are doing this to our own future-what some might call imploding. Anything new or different has been viewed totally in dollar terms, with a short time span in which to produce results. The attitude is, "I tried it, but did not make any money, so it's no good," or "It used to work, but not any more," or, if it's a new product, "Who's going to use it?" Or the biggest cynicism of all, "Once everyone has it, it will soon be self defeat-

WHERE Do WE Go FROM HERE? 129

ing." This mind-set is a major barrier to effort and a self-confident spirit.

All this is taking place at this very moment against a backdrop of utter failure in a true business sense -customer failure. I think

it's pretty clear that what we have today is inadequate for our

growth and role in the future. Given the mere assumption, if one

is not willing to concede the fact, that the market's database is

being misrepresented in important ways, it is logical to expect some type of exploration of new ideas. Has education or under

standing ever produced an attitude of self-destruction in other

industries? If people use basic business principles and under

standing, does it become self-defeating, or does it grow the industry? Is it a very big step to apply logic to a dynamic data base,

instead of one that is one-dimensional? Being proactive means that we can learn from our experiences,

and use them as a base to go forward. It also will attract new

people to the industry, and the industry will therefore grow. As a long-time member of the CBOT, I have always viewed our success to be, not the number of contracts traded, but the number of

new faces that showed up to compete. During my active floor years, there was almost always a new star or stars who showed us new and better ways to go. The older stars did not necessarily fade, but adjusted to the new situation, as it was the new situation that let the new succeed. Is there a lesson here?

I would like to point out that while we are all strong supporters of our industry, and we are on the same ideological path, there

are two sides of that road. The left-hand side represents doing things the same old way. At present, I see our industry growing just because we have a presence in the marketplace; if that is the

case, it could ideally be growing at a far greater rate. If the rate is low, we have to ask what are we offering. If it's not much, the business that was automatically ours will soon be done in a different way somewhere else. Is our infrastructure functional for the times and opportunities? Are we presenting real opportunities? I am not of the opinion that our industry is meeting these


needs, or that it cares to. It all starts with direct communication from us to our customers. Is what we are doing being correctly

presented? If not, then this would be the left-hand side of the road.

In this light, let's look at our most prominent industry descrip

tion, that the market is a zero sum game. Do we deserve it? Why

does it seem to persist? As an industry, do we really care? Personally, I hate it. I never equate the market to a game, because I

don't know its rules or its time frame. Everybody who uses the market has a different time frame and different objectives. I have always thought and experienced the market to be dynamic. The

role efficiency plays never allows the market to revert to zero, but only to shift between conditions of itself.

Growth is non-static, and I feel that anything growing is never zero, that the market serves and that it's a growing type of service. Any business that doesn't grow isn't going to make it any

where. To say that there's a loser for every winner does not make sense in a growing environment. It's like musical chairs-as long

as the music is playing, there is no loser. Music is growth, and we should not let it stop playing. When the music stops playing, someone always drops out, but that person does not necessarily lose. For instance, in some of their studies the Federal Reserve

have come to the conclusion that there are too many banks. This means that some banks will be gone in the future. They can be merged, bought out, etc., and the banking industry can effectively grow to serve our needs.

The right -hand side of the road would be a path that would lead people toward their goals. It need not detail every step, but

must allow for discovery and growth. In simpler terms, it means pointing out what we are, what we are doing, and what we offer, and making certain it's the best we can do. These simple steps have not really been understood by our industry. There is an under-utilization of the asset base we now have. Putting all the various talents in the industry in a closer working relationship to the market would unleash a much greater level of growth.

WHERE Do WE Go FROM HERE? 131

We need to get beyond our current stalemated position, and, in doing so, explain the advantage to being associated with the opportunities we offer. It would be fair to say that in the past the

professional trader had a distinct advantage. Access to informa

tion, time devoted, experience, location, all allowed one to overcome most basic handicaps. Those outside of this framework were

at a distinct disadvantage. Today, advanced forms of communi

cations are delivering information in a cost-effective manner and

without geographical bias. Computer processing power has ar

rived and can be effectively used by all types of participants. No

market is isolated from world events. With markets moving globally to an around-the-clock environment, we will soon have a

new and level playing field. Computers will be in place to com

pensate for the missing time factor, as all traders will have some

type of time gap to handle. Computers will begin to do some processing even for the floor local. They will eventually do more

and more of this, and do it better than the floor local used to do it. Everyone will have to be better prepared for whatever role they intend to play.

All this means that the industry is poised for change, and we need to be ready for it. As the "zero sum game" idea implies, it is

those who use the markets who are thought to be the losers today, but it will be those who do not use them who will be the losers of tomorrow. In a recent article, R.C. Longworth, a senior writer for the Chicago Tribune, cites a study by the Institute for Policy Studies in Washington, DC. The study states, among other things, that 51 out of the 100 largest economies in the world are not

governments, but corporations. Longworth asks a very good question: Where will control lie now, as this trend accelerates in the global atmosphere? If I were to give my answer, it would be in the markets, and not with government. Even now, it has been the markets that have really transformed the landscape, not the Federal Reserve and their counterparts around the world. The oppor

tunity for our industry today is unparalleled versus any time in our past. We need to center our efforts on knowledge, education,


and openness to new approaches. We can do a lot better, and must discover the fact that we have to.

Consumption is the main driving force in all societies, whether

it is due to the wealthy wasting resources, or to the poor overpopulating, or just to natural/abnormal growth disparities.

Market opportunities have been and are being created. We can and must do a better job than we have been doing to service this basic need. If we avoid the risk of having our industry implode as

a result of our inability to innovate, we face the complementary

risk that the opportunity could engulf our inadequate infrastruc

ture, and we would stand a good chance of getting lost in the process. It's hard to justify how you missed out on success when

it's past you. That is a position that we do not want to be in. The future is in our hands, and we collectively need to be a concerned

leadership.

Index

Symbols

3-1-3 89, 90

3-2-1 89, 90

B

background 1, 6, 10, 21, 25, 26-

28, 36, 47,48, 73, 88,91, 97, 108, 111, 125

background efficiency scan 108

beginning traders 10

bell curve 4, 6, 7, 32, 37, 65, 75, 89

Berkeley 75

big traders 6

blueprint of development 90

Boyle, Mike 65, 89

British Pound, example using software 107-111

business principles 9

c

Canadian Dollar, example 107-111

capital flow 33

capturing Market Data 61

CBOT (Chicago Board of Trade) viii, 3, 10, 129

Chicago Tribune 131

chronological time 4, 37, 61, 81, 89

Cocoa, example using software 93, 94, 122

collective dominance 121

Commodity Trader Identification Codes 65

computer processing power 131

computer productivity 18

consensus 77, 44, 59, 112

control 44

cn codes 2, 3

133

134 INDEX

D

D-mark, example- data base controller 116

Data arrangement 69, 74

data base 1, 74

data base controller 113, 113-121

data entry system 4, 5, 65

data organization and representation 5- 7

day profile 34, 83

development 62

development as a trader 8

dimensional measurement 107

dimensional movement 56

discipline 6

discipline of the bell curve 76, 78

distribution theory 34

dominance 6, 46, 48, 50, 70, 84, 86, 91, 96, 111

dynamic efficiency 36, 78, 105

E

early experience 10

efficiency 3, 5, 13-15, 21, 26-28, 33, 35, 38, 39-48, 57, 100, 116

Emory, William Uhlman 58

F

fair price area 39, 41, 59

Federal Reserve 130

financial control 1, 6, 10, 23, 47, 106

first standard deviation 32, 36, 65, 76, 86, 89, 92

Five year note, example data base controller 115

foreground 13, 47, 48, 109, 118, 119

four steps of market activity 90-91

fragment 55

fundamental analysis 8

G

Graham and Dodd 8

Griffin, Bill, Sr. 51

growth 130

H

horizontal 36, 39, 43

horizontal and vertical axes 61

I

industrial indifference 23

inefficiency 14, 16, 33, 57

Institute for Policy Studies 131

internal controls 22

investing 8

J

Jirout, Bob 65

K

key to objectivity 37

Kirby iii

Kummel, Gordon 71

L

large trader 6

LIFFE exchange 88

liquidity 6, 45,46, 49, 56, 83, 111

Liquidity Data Bank 66

Longworth, R.C. 131

lull 6, 49, 87, 91, 96, 113, 119

M

market activity 11

market behavior IO

market cycle 40, 43

market data base 125

market development time 77

market discipline 13, 16-17, 21-24, 52, 76, 78, 80, 86, 91

market efficiency 5

market organization 42

market output 41 , 57, 77

Market Profile v, 4, 5, 7, 28-32, 88, 127

Market Profile, dynamics of 93

INDEX 135

136 INDEX

Market Profile, updating understanding of 79-91

market time 62, 90

market's development 62

market's process 40

market's purpose 5

mean 32, 75

measurement 5

Measuring dimension 56

minus development 87, 91

mode 32, 76, 82

money management 10, 23

mutual funds 1

N

neutral day 86

non trend 81

non-efficiency 39

non-trend day 86

normal days 81

normal variation day 81

o

objectifying the market 70, 103

objective trading parameters 80

opportunity 8

p

Page 2 mark 115

phonemes 104

Pollack, Bill 71

prediction 9, 10

price 125

Price discovery 41

price plus time equals volume 66

profile, formula for 66

purpose of the market 33-38

Q

Quaker Oats 87

R

Randomness 45

randomness 6

range extension 82

Rosenthal, Les v

s

saying 9

sayings 9

scalper 11

scalper-spreader 11

scan indicator 108

Security Analysis 8

SFE 88

Silver, example 107-111

small trader 6

Snapple 87

software, Page 2 71

software, studies 99-101

speculation 8

standard deviation 76

stops 11

T

Ten-Year Notes, example-data base controller 120

The Bell Curve 75

third standard deviation 83

Trade facilitation 86

trade facilitation 33, III

trader discipline 11, 22

trader's development 127

trading plan 7

trading programs 72

trading system 38

trapped money 97

Trend 81

trend day 97

two dimensionality 55

two-dimensional data organization 75

two-dimensional display 61

two-dimensionality 61

INDEX 137

138 INDEX

two-phased market 34

u

u.c. Berkeley 8

v

value 5

vertical 5

vertical background 59

vertical dominance 119

vertical extremes 77

vertical market phase 6, 58

vertical reference 41, 58

vertical/horizontal relationship 56, 116, 119

volatility 74

volume data 3

z

zero sum game 131

141 West Jackson - A Journey Through Trading Discoveries by Copy

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