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KNOWING WHAT TO LOOK FOR

The first riddle I ever remember hearing was asked by my mother; “When you are
looking for something why is it always in the last place you look?” Of course I was
puzzled until she said, “because then you stop looking because you found it.”

Sometimes in trading we look right at something we were looking for but don’t realize
we actually found it, and so we continue looking. We are constantly writing that markets
are very visual, which means that, very often, they will auction to a level that is very
visual on our charts and graphs. Along with this we often attempt to identify potential
“destination” trades; the destination is also a very visual market level. We are not saying
that the market will necessarily arrive at the destination; however, if the market begins
to auction in the direction of the destination it is certainly a targeted level. Let’s look at
an example from Friday Oct 15, 2010 that meets both of the above qualifications: it is
visual and a likely destination.

Opens in lower range

of two day balance
CRUDE OIL
DAILY and auctions out of
range
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We always talk about levels rather than specific prices; attempting to try and be too
exact will, very often, freeze you in place as you try to squeeze out every penny from
the existing trade or cause you to miss initiating a new trade. Let’s examine the same
trade via the Market Profile.

CRUDE OIL

Market opens
and is trading
out of balance

Practical application:

1. Consistent and return readers know that one of our favorite trades is a
breakout from balance; breakouts represent change and change spells
opportunity. Consider if you came into the morning with a plan recognizing the
two day balance in context with the longer term conditions. We refer to a
trading plan as a Narrative, which is your overall view of the market. Following
the narrative are a series of scenarios. Scenarios are possible directional
trading events for the day; one of the scenarios in the above situation would
be for a downside breakout. See our balance rules in our glossary for further
explanation of how we trade balance areas.
2. Value immediately begins to build lower; we trade value not price.
3. During G period, the seventh 30 minute trading period, the auction begins to
auction aggressively lower. A visual market audience, these are likely to be
skilled and experienced traders, has already locked in on the visual gap as a
likely target. Who do think has the edge?
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Visual perspective: Anyone with experience knows that the previous day’s high and
low are relevant to today’s trading. This high or low may only be relevant in slow
markets because shorter-term traders want to run the stops and fade price moves back
into the range. However let’s extend this to longer time periods. On those days that the
longer timeframes have an interest, whether it is to “go with” a breakout or fade the high
or low, a longer-term high or low is very visible as well.

For example, if a trader did not look at the monthly or the weekly bar for the 30 Yr
Treasury bond below, he probably would not have recognized the price level(s) that
may interest the longer timeframes; it is unlikely he will have a longer-term perspective.
The Field of Vision video discusses this in depth; understanding timeframes and how to
interpret their participation takes experience gained over months and years. We suggest
labeling references in terms of timeframes (day, short, intermediate, long-term) so that
you have a better appreciation of references.

This monthly Treasury bond chart was captured on Saturday, Oct 16, 2010. As I edit
this article on Monday, Oct 18, 2010, bonds closed at 132.06, more than a handle off
the two month balance low of 130.25; do you think this rotation back up into range is the
result of the day timeframe trader? Probably not.

Oct low
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The monthly bar allows for a visual review of the previous month’s highs or lows exactly
as a daily bar or weekly bar would do for shorter timeframes. In the above example you
see that the October low failed to take out the September low by three ticks. The
majority of struggling traders I talk with have no idea about these important visible
references. If you have not looked at the charts and you are not aware of the
references, you will be at a disadvantage for day trading or longer-term trading when
the level is reached.

We refer to this as a “Top down-Bottom up” approach: first gain a bigger market
perspective by looking at the longer-term charts. Then use short-term and day
timeframe market-generated information to formulate strategy and a tactical plan from
the ‘bottom up’.

Visual perspective continued:

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We often get so focused on the short-term, economic reports, and the talking heads that
we fail to keep a perspective of what the market is actually doing; a visual look at the
monthly bar quickly allows you to see that;

1. We see an excess low near the 1000 level back in July—excess is one of the
most important concepts we work with.
2. One-timeframed higher for three months in a row.

One of the best ways to ward off cognitive dissonance is by maintaining a solid overall
perspective of the market.

We could certainly add multiple examples; however, the objective was simply to expand
your awareness of how visual the markets are. When you reflect back on this idea you
quickly realize how logical it is. We are drawn to what we can see and become
comfortable using it to our advantage.

Depth and market perspective will increase when you start to view longer-term charts in
conjunction with the short-term. Many traders do not review the longer term charts or
they just have a cursory look. Or, they are looking at indicators or other derivatives of
price rather than observing the visual levels on the charts. Often times the relevant
information is right before our eyes; but if we don’t know what to look for, it’s difficult to
find it.

Going beyond the Majority of Those You Compete Against

What we have shown so far is available to all that have access to traditional bar charts;
we can take visibility up another level by viewing Market Profiles®. The Market Profile® is
actually a real-time, time sensitive, evolving data base that displays its data in structural
form via the Profile graphic. The bar charts that we reviewed earlier are one
dimensional; a Market Profile® is two dimensional which allows us to see the market in
greater depth. We can see patterns via the structure that allows us to differentiate
between price and value, which is at the heart of all rational decision making. We can
also observe patterns that suggest that inventory in different timeframes is either too
long or too short. Additionally, we can see anomalies in the structure that need to be
repaired. Repair can only take place when price returns to the scene of the anomaly.
Let’s view a couple of examples.
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S&P 500 DEC 2010

An anomaly is a single price or level that lacks symmetry, an unusual structural

arrangement in the Market Profile®; the above is described as an anomaly because
price traded at the POC or fairest price to conduct business in all but one of the daily
time periods, a very rare occurrence. The odds are very high that this anomaly will be
revisited; it normally requires substantial volume away from the anomaly to open and
not revisit such an anomaly. Those who had visual access to the Market Profile had a
clear advantage. Note: I understand that the above paragraph lacks a full description
and explanation; however, the point of this article is to highlight the importance of visual
market references.

Our final example is more complex and subtle; however, we have several clients that
have effectively traded with this visual picture in mind.
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1. Our starting point; a fairly balanced day; notice the anomaly at 82.08 and how
visual it is.
2. Market opens and rallies to 83.07 in 2nd period (B) before retracing to trade at
anomaly from day one. We are overusing the word anomaly here; we would
normally refer to the anomaly level 82.08 as the POC or fairest price at which
business is being conducted.
3. Shifting gears; I want you to notice how almost perfectly the daily lows are
beginning to fit a short-term trend line—this is a very visually displayed.
4. The market continues to conform to the visual trend line.
5. The mechanical trend line that has been the buying reference for the short-
term momentum traders.
6. Once the mechanical trend line that has been buy point for the momentum
traders is penetrated, one set of stops sets off another, sets off another, etc.
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Explanation: Our goal continues to be to focus on how you can use your eyes to
become a more proficient trader; however, a brief discussion will be helpful. When a
market conforms almost perfectly to a rising trend line it is often a sign of mechanical,
short-term momentum traders continually getting longer and longer. Longer-term buyers
are unlikely to attempt to be as exacting as their size makes this impractical. As these
short-term traders continue to take long positions, they are likely placing protective
stops below each new daily low.

Point 1: As long as you understand exactly what is occurring, you can benefit in two
ways:

1. Employ short-term day trades going with the short-term trend; buying as close to
the trend line as you can. I’m not a trend line person; however, if this is what the
momentum traders are doing, go along, it is all a game anyway. The key is to
fully understand the game and be ready to exit immediately if price begins to find
acceptance below the trend line.

Recall that we assumed that these traders are placing stops under each new daily low;
as the rally continues long inventory continues to build with weaker and weaker hands,
which we refer to as laggards, holding the inventory. It is important to recognize the
game and to feel the greed of the laggards, knowing that inventory is likely getting into
weaker and weaker hands. This process can continue for extended periods if nothing
knocks the traders off track; traders will continue to do what works until it stops.

2. Once a correction gets underway and the stops begin to get triggered, it is very
often, like a pack of firecrackers being ignited. When the first stop level is
triggered prices are driven low enough to trigger the next set of stops, etc. You
will often see several days of gains erased in a single session. If your imagination
felt the inventory accumulating within the hands of weaker and weaker traders
you would be able to visualize the liquidation if it occurs.

Imagination + Analysis = Comprehension is our tag line for our video and website;
being able to visually see the market can greatly increase this process of imagining the
possibilities and being prepared. Review the last example and begin to appreciate how
an understanding of what was occurring will help you imagine the break on the last day.

Trading is about employing all your senses to compete successfully; too many traders
remain too narrowly focused on price and short-term bars, never fully appreciating the
market’s natural two-way auction process, the multiple timeframes, and the expected
behavior of each of these timeframes. Taking the broader view will not only expand your
market perspective but it will also protect you in the day timeframe from being
mesmerized by price.