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KEEPING MARKET PROFILE IN PERSPECTIVE

In the beginning of Donald Rumsfelds new book he describes a condition very applicable to
trading:

1. There are things we know that we know.

2. Things we know that we dont know.
3. And finally, there are things we dont know that we dont know.

If you have never hit a solid golf swing you dont know what it feels like and you dont know what
you are working towards. When you have hit the one near perfect stroke, even if you cant repeat
it in successive attempts, you now know what you are trying to achieve. When you can begin to
understand the process of integrating multiple timeframes, the inventory conditions of each
timeframe, and develop a contextual understanding of the big picture, you will see the day
timeframe auction from a much different and more meaningful vantage point than the majority of
your competitors.

The foundation of everything we do revolves around the auctions natural two-way auction
process. The continuous auction process is occurring among multiple timeframe auctions
extending over months at a time. This approach drives our analysis, our perspective, and
ultimately, our contextual understanding. From here we develop a trading strategybe it for long
term investing, position, intermediate, short term, or day timeframe trading.

The longer the timeframe auction, the more complex it is. Factor in multiple timeframe auctions,
inter-market relationships, and the conflicting information and ambiguity that arise from these
considerations, it is not surprising that many traders narrow their focus to the very short term. In
most endeavors it is easier and more comforting to get our minds around short-term data, which
can lead to a blindness of the more important longer-term information. Forming a backdropan
overarching understanding of the complexities influencing the marketcan provide traders an
edge that builds over time; a depth of market understanding that sets traders up for bigger
opportunities, reduced vulnerability to unwelcome surprises, and ultimately greater potential for
long term trading success.

What happens in the day timeframe is often a reaction or adjustment that emanates from market
conditions that exist in the next longer timeframe or perhaps even longer timeframe. Without
recognizing this it will be very difficult to gain a contextual understanding of why the market is
doing what it does in the day timeframe. Armed with this understanding you increase your
potential to envision the possibilities and remain flexible to assimilate the total scope of the
market-generated information. There are day timeframe auctions where a trader can execute in a
vacuum and be successful, but the majority of time this narrow approach will not lead to
consistent trading over weeks, months, and years.
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SynthesisThe Culmination of Analysis

We prepare for each day with a top down approach starting with the monthly bar or longest
timeframe; this is followed by reviewing the weekly bar, the daily bar, and finally the Profiles. This
analysis develops an understanding of the broader market; from here we view the Profiles to fine
tune our perspective and formulate a tactical plan that considers the shorter term, current market
conditions. Through this process we collect various data, rank their importance, and synthesize
the various components to form a market perspective that mentally conditions us to be flexible,
effectively deal with the markets uncertainty, and imagine the possibilities. This is at the heart of
our tag line Imagination + Analysis = Comprehension.

The Market Profile

The Profile is an important component of our approach however a single Profile is not a panacea
for understanding the complexities required for successful trading. We do depend more heavily on
the Profiles for our tactical plan however no one Profile by itself can provide the necessary
information to trade profitably day in and day out. We will be better served by focusing on a series
of Profiles rather than on a single daily Profile. Viewing cumulative individual Profiles are more
expansive and, similar to our long-term approach, will provide a more contextual understanding.
This more expansive contextual perspective becomes very important in providing the framework
on which to base shorter term tactical trading decisions. Even during a single day there are often
multiple auctions occurring; understanding the contextual conditions surrounding these day
timeframe auctions will better equip us to respond appropriately.

Synthesis as it Relates to Trading

Synthesis is an integral part of trading strategy as well as analysis. Odds based trading is a
necessary component of long term success. Continually considering the odds and thinking in terms
of probabilities requires our minds to remain focused on the big picture; understanding the odds
of any trade require that we have factored in the range of information affecting the auction. We
will explore odds based trading through an example in conjunction with applying a top down
approach and bottom up strategy formulation.

30 Year Treasury Bond Example

Lets look at some of the factors that went into making a rough odds assessment for the morning
of Friday, February 11, 2011:
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30 Year Treasury
Bond Daily Bar

Prior to and since the sharp break on the previous Friday, February 4, 2011, the market had sold
off sharply. On Wednesday, February 9, 2011 a new weekly low was put in to continue the weekly
one-timeframing down mode. On Thursday, February 10, 2011 the market closed in the lower
portion of the daily range. Traders who went home short on Thursday likely felt pretty confident;
it appeared to be another weak day.

However, traders who understood how to view market structure more closely would have
reduced the odds for downside continuation; they would have observed the very poor high as well
as the very prominent level where the fairest price at which business was being conducted (POC)
on Thursday. Recognizing these two observations would have shifted their attention to
Wednesdays excess low and would have increased their odds assessment that the excess low was
more likely to hold. If the excess low holds, the logical scenario in these traders minds is that, at
least, a short covering rally would ensue. Of course we never know what might happen however
we can make a reasonable assumption that with Thursdays low being so close to Wednesdays
excess low, if there is no downside follow through on Friday, the odds have greatly increased that
the market will rally. The morning pre-market update that we sent out prior to Fridays pit session
cautioned that the market was very short.

As we mentioned, Thursday closed down not far from the new weekly low setting the stage on the
morning of Friday, February 11, 2011 to make an assault on the new low. With the market being
weak this attempt seemed reasonable; however, if the market did not auction down to this low or
show any sign of conviction to the downside, the odds were very good that the market would rally.

If you were trading exclusively from the Profile in the day timeframe on Friday you would have
observed the wide POC from Thursday and an open Friday morning near the top of balance. Trade
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location to add or put on a new short position was excellent. The conviction off the open was
lowprices were not breaking out of balance nor were they going back in balance. If you were
focused on the Profile from Thursday and the very short term, you would have missed the more
important information; multiple timeframe inventory was becoming increasingly short; the risk of
the shorts was increasing.

We knew from the shape and structure of some of the Profiles that are shown below that the
market had not fallen as sharply as price and your intuitive feelings might have led you to believe.
Thursdays weak close could have easily strengthened this sentiment; however employing a longer
term perspective and the market-generated information would have enabled you to envision
multiple scenarios to the contrary.

30 Yr Treasury Bond Profiles

We have already discussed some of these items under the daily bar but want to lay them out
under a Profile chart to help you in the internalization process of assimilating the various pieces of
market-generated information:

1. Thursdays Profile had unsecured or poor high, along with a very prominent POC. Late in
the pit session on Thursday there was a break away from the wide POC. These
observations factored into the odds of continuation as you prepared for Friday.

2. The most important aspect of any Profile is the value area as it is forces us to focus on
value versus price; remember we trade value not price. As you can see, value was
struggling to go lower. Although Thursdays price closed in the lower range, Thursdays
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value was in higher end of Wednesdays value area. Price was pressing lower but observing
value revealed quite a different picture.

3. On Friday morning, the market opened near the top of Thursdays range. If we did not see
price move back into Thursdays range, value was likely to be higher; another piece of
market-generated information that the odds were decreasing for downside continuation
while the risk of being short was increasing.

4. There were also psychological factors; if you were short all week, wouldnt you feel secure
that the market broke and closed in the lower portion of the range? The trader that didnt
fully appreciate the market-generated information would probably feel that the odds were
good that the market would go lower. However a trader that appreciated the factors we
have discussed would likely have adjusted their odds based understanding. Structure was
telling you that the inventory was struggling on the downside; the inventory conditions in
multiple timeframes were becoming increasingly short. A trader that was considering
longer term market conditions could have envisioned a very different scenario than most
of his narrower perspective competitors.

5. As the market opened higher on Friday it would have been helpful to have already been
inside the heads of your competitors. You know many traders are short and inventory
conditions suggest that traders are short in multiple timeframes. On Friday we saw a short
covering rally that squeezed many short positions. Those traders that were not considering
the odds, risk, or longer term market conditions were caughtnot only by the move up
overnight by 20 ticksbut also by the additional 25 tick move from the open that showed
frantic emotional short covering during the pit session.

Summary

Mind over Markets, my first book, takes you through the five steps of progressing from novice to
expert. The article you have just read provides a flavor for how traders think and act at the expert
level.