Many traders rely, at least in part and often in a less rigorous way, on the Market Profile model first introduced in 1984 by J. Peter Steidlmayer. Mind over Markets: Power Trading with Market Generated Information (Traders Press, 2d ed., 1999) by James F. Dalton, Eric T. Jones, and Robert B. Dalton is a thorough explication of Market Profile charting concepts. It should be required reading for anyone using Steidlmayer’s model and its innumerable knock-offs.
I happen not to trade this way, though my style shares a few of the ingredients in the Market Profile auction model. I could therefore read the text looking for more general insights and skip the pictures! It made my task much less daunting.
In analyzing market structure, the authors are inclined to anchor intraday activity to the way the market opens. “With an understanding of market conviction, it is possible to estimate very early on where the market is trying to go, which extreme is most likely to hold (if any), and even what type of day will evolve. In other words, the market’s open often foreshadows the day’s outcome.” (p. 63) There are four basic types of opens—the open-drive, open-test-drive, open-rejection-reverse, and open-auction, all analyzed in some detail.
One of the theses of this book--familiar to many, very profitable to few, and treacherous to the unwary--is that “the best trades often fly in the face of the most recent market activity.” (p. 107) That is, when a market trades above or below an accepted reference point and fails to follow through, this often sets up a powerful reversal trade. And if the reference point of a higher time frame supports that of the lower time frame, the reversal move can be even greater.
It’s important to note that the reversal trade first requires a failure. For instance, the market trades just above a previous intraday high and then runs out of steam; the buying dries up. Or the market trades just below the previous day’s low and then stutters; the sellers start to mark up their merchandise. After a “confirmation,” the trader should place a trade in a direction opposite to the previous trend.
The reversal trade, improperly executed, will be no different from the doomed attempt to pick tops and bottoms. But the trader can put some filters in place to improve his odds. And he can keep a pretty tight initial stop since his hypothesis is straightforward—a powerful reversal trade should be strong right out of the gate. By the way, I would add a note here. On very small timeframe charts there’s almost always a little back and forth movement at obvious support and resistance points, so it’s imperative to move up at least one timeframe to get rid of the noise and determine whether there is continuation or failure.
Although Mind over Markets is most definitely not a book about the psychology of trading, in the final chapter on proficiency the authors offer practical advice about such topics as managing inventory and knowing your competition. They also venture into the realm of left-brained and right-brained activities and suggest that “after the market’s close . . . the analysis of the day’s activity and preparation for the following trading session are best accomplished by using predominantly left, analytical talents. On the other hand, when the market is in full gear, the fast-processing, free-associating right brain should have more control. Ideally, we should strive to operate in a more ‘central’ hemisphere, freely calling on both sides of the brain to contribute when needed.” (pp. 317-18) For those who are predominantly right-brained or left-brained and can’t achieve the ideal of whole-brained trading there’s a fallback position: “By knowing your left/right brain strengths and weaknesses, you can begin to develop a trading strategy that best uses your individual talents.” (p. 318) If you don’t know where you fall on the left brain/right brain spectrum, there are lots of free tests available on the Internet.