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How o use market profile to trade Futures

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Trading isn’t for everyone, and every trader develops a trading style that best fits their personality. Some traders are more attuned to day trading short time frames. Others swing trade and let a position ride for a few days. Still others have long time horizons. The beauty of trading the markets is that there are strategies tailored for each type of trading personality.

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But first, you need to ask yourself “How much money am I prepared to lose?” What are you prepared to invest in your trading business, and how much are you prepared to lose if things go terribly wrong? Once you have taken personal responsibility for what you invest and what you’re prepared to lose, then you can identify what trading style is best suited to your personality.

3 cores of the trading zone system:

The TradingZone System is built on three primary pillars:

  •  Market Profile – A tool used to assess the broad market. It’s like a big-picture roadmap. If you are driving from New York to Chicago, you need to know you are heading west. Where does the market want to go, and which direction is it going?

  •  Patterns and Inflection Points – There are some places on the charts that are better opportunities than others. Something has happened in the recent past that’s a better place to take a trade, or something has happened in the recent past where it’s less advantageous to take a trade. Market Profile gives us the direction of the markets. Patterns and Inflection Points give us the best spot on the charts to make a trade.

  • Price Action Order Flow – The final step is to take a look at Price Action Order Flow. Once we have determined the direction of the market and where on the charts we need to trade, and we want to go long, are other traders moving in that direction as well?

The fourth pillar is Money Management. The reason why this pillar is separated from the others is that the first three pillars are determined solely by the market. Money management is determined by the trader, and it goes back to the human element of understanding what type of trader you are, how much you are prepared to lose and how you manage your money. 200 traders in the same trading room, using the same tools and methodology, will have 200 different P&L statements. We are all unique in our trading personalities.

A Key Tool for Developing a Positive Trader‟s Psychology

In order to trade successfully, you need to learn how to trade consistently. One of the first things you can do is to set a reachable, reasonable daily goal. Let’s say it is $50. Once you reach that goal, stop trading for the day. Once you have become accustomed to reaching a daily goal and stopping, thereby protecting your earnings, it becomes easier and easier to do. As your account balance increases, you can gradually increase your daily goal as you move forward.

With the proliferation of HFT (High Frequency Trading) firms, and growth of electronic trading, it would be safe to say that the vast majority of trades executed rely heavily on programmed systems and tools. The independent, self-directed, gut feel trader has become a thing of the past. I believe you would be hard pressed to find a trader today that does not rely on or consult some form of electronic or computer generated data or indicator before placing a trade.

At the extreme level there are systems entirely controlled by computer algorithms that do not rely at all on any human intervention. It has therefore become more important than ever for traders to have a deep understanding of these tools so that they can compete on a level playing field. At the very core of this is the notion of Market Structure. Market Structure similar to Trend Analysis essentially tells the trader which direction a market is likely to trade.

But unlike Trend Analysis which can be quite basic, a simple as drawing trend lines on different time frames, Market Structure as defined by Market Profile provides a far greater depth of analysis. Trend analysis will tell the trader where a market has been, by drawing a trend line through data points that best fit he current data set, a.k.a a trend line. From there the trader will extrapolate in a very linear fashion where the market is headed. This is a very simplistic and 1 dimensional approach and makes the assumption that a market will continue to trade on the same trajectory (slope) in the near future as it did in the recent past. Unfortunately this is rarely the case, and not until the charts show a trend line break can we analyze, in hindsight what has occurred.

By contrast, Market Profile provides a set of known Market Structures that are built around the notion that markets with a common structure will trade in the same way. As an example a market that has broken above its value area high will continue to rally as this is a market that has attracted initiating buyers. To the simplistic trader they will say the market is trending up, however we can see from the Market Profile charts that there was in fact no discernable trend until the price broke above the Value Area High. So what we have is a clear contrast in technical analysis approach between Trend Followers and Market Profile Traders.

The Trend followers will almost always be late to join the trade because by definition they would need sufficient data to be able to confirm the trend. Market Profile traders would be the earliest to join in the trade because, again by definition, a price that trades above the value area high is known to attract initiating buyers, and that can happen with only a few trades executed at that price level.

So what we have is 2 different tools, both used to attempt to predict market direction. 
1) Trend lines which will rely on past data points but will cause a lag for the trader to take action as the trend lines are backwards looking and simplistic in their assumption of markets continuing to move along the same slope. 

2) Market Profile which provides ‘break levels’ at which the markets are known to transition from non-trending to trending.

These levels are known by the trader well in advance. In short Trend lines look backwards while market profile looks forward. I have heard that some of the most sophisticated programmatic algorithmic trading systems are built around Market Profile, it surely makes sense then for the independent trader to take the time to learn it in order to compete effective in an every increasingly sophisticated market The charts and examples that follow are a good first step to understanding Market Profile and how it may help you make better trading decisions.

Market Profile

The First Pillar Market Profile is the most powerful and the most fun indicator to learn. It was originally developed in the 1900’s by J. Peter Steidlmayer, a floor trader on the Chicago Board of Trade, who subsequently licensed the program to the Chicago Board of Trade. Market Profile has been taught by numerous educators, and some have over-complicated it. In the TradingZone System, Market Profile is essential, but it is also greatly simplified.
Market Profile  Defined:

Market Profile organizes one single day’s trading data into a simple distribution curve. On the right, you have the prices that traded throughout the day. The letter blocks are plotted every time a specific price was traded. The letter blocks move from left to right as time moves forward. During the course of the day, as all the letter blocks are being plotted on the chart, it builds a distribution curve until one of those rows stands out the furthest. This row of letter blocks is called the Point of Control (POC). It is the price level traded more frequently than all of the other price levels.

To put it another way, it is the price where most buyers and sellers met to exchange product. It is the center of gravity, or the equilibrium point of the market. It is the most accepted price on the market. Once the POC has been determined, the Market Profile calculates one standard deviation on either side of the POC, creating theUpper Value Area and the Lower Value Area. 

All of the data between the UVA and LVA comprises 68.3 percent of all of the data for the day. If you flipped this data on its side, it would look like the bell curves taught in statistics class. What this information tells us is that the relevant prices, or the most accepted prices, happened within these 2 boundaries. The irrelevant prices, which were the prices with less acceptance and less volume, occurred outside the boundaries.
When you superimpose Market Profile on the daily charts, here’s what it looks like:
The chart becomes more visually appealing, and easier to understand. You can clearly see the uptrend with the brackets between the UVA and LVA stacking on top of each other. It’s much better, but it can be simplified even further.This becomes even more visually appealing to traders. The Market Profile indicator is now superimposed on a candlestick chart regardless of the time frame you are using. If you have a visually appealing chart with patterns that are easily recognized, then the probability that you will hesitate to make a trade is diminished.
This becomes even more visually appealing to traders. The Market Profile indicator is now superimposed on a candlestick chart regardless of the time frame you are using. If you have a visually appealing chart with patterns that are easily recognized, then the probability that you will hesitate to make a trade is diminished. On this chart, the green shaded area is the same as the Market Profile on the smaller chart above. You can easily see how the Point of Control drives the market. Above the green shaded area you can see yesterday’s Point of Control, Upper Value Area and Lower Value Area, so you can compare today’s price to yesterday’s value.

Yesterday’s charts established the value of the market. Has it become cheaper or more expensive? This chart lets you know whether you are trading above value, below value or inside value. We can use these charts and value levels as a basis for making trades, or as guides to market structure and direction. Market Profile gives you the information instantly to identify if a market is range-bound, or whether it is trending.

This is a market that is building value. When you try to draw trend lines on traditional charts, it can become difficult trying to plot a clean trend line due to periodic spikes. When you see how the value brackets line up, it’s much easier to draw a trend line that is more objective and quantifiable.
In contrast, this is a market that is losing value. The value brackets are being set up one below the other. There is one period where the market is actually bullish, but it is a reactionary movement away from the greater downtrend.
In this chart the brackets are in line with each other, making this chart value neutral. It’s range-bound, so you can look to sell off the upper range and buy off the lower range. So how do you identify a good entry opportunity?
This is a market that is neutral. It is contained within the upper and lower boundaries, providing an opportunity to buy off the low range and sell off the high range.
Here’s an example of a market that had a number of opportunities. This is more consistent with an active market. You tend to get 3-5 opportunities in a day. Support was tested twice and the market bounced back off the Upper Value Area.
This is Market Profile superimposed on a 2-minute chart. You still get the information you need for setups on a shorter intraday time-frame.
This is an example of the 80 percent rule. It was a term coined by the makers of Market Profile because it works 80 percent of the time. When a price breaks out of the bracket, it will move to the other side of the bracket when it re-enters the bracket 80 percent of the time. It will travel from one extremity to the other.
With Market Profile in place as your primary indicator, you will notice that the market will almost always make a big move if it bounces off a value area, whether it’s the Upper Value Area or the Lower Value Area.

Market Profile and the TradingZone System give you the tools you need to make objective and quantifiable decisions about determining the direction and structure of the markets. Market Profile also works on all markets whether you trade the eminis, stocks, commodities, ags or forex.

Key benefits include:

  •  Market Profile is Different from other Indicators. It determines if the market is long, short, trend or range-bound
  •  It is Easy to Learn. Your chart isn’t cluttered with useless information
  •  Works in Any Market. Forex, Futures, Indices, etc.
  •  Clearly Identifies Optimal Trading Price Levels. It makes entries objective and accurate.
  •  Provides Entries as well as Exits. Keeps you in the trade for big moves
  •  Objective, Accurate and Precise Rules-Based Trading. This is critical because without it you are just trading on information and not a methodology

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