92 July 1998 Bloomberg

Is there a way to display priceinformation without using stan-dard bars, lines, or candlesticksa way that greatly increases thevalue of such information to in-vestors? There is. Its a technicalanalysis tool called Market Profilethats favored by thousands of mem-bers and salespeople on the floor ofthe Chicago Board of Trade (CBOT).Market Profile was the brainchild of asoybean floor trader named PeterSteidlmayer in the 1960s.

Steidlmayer realized that intradaymarket activity could be presentedmore effectively by organizing tickdata into distribution curves ratherthan in bar-chart format. He there-

fore substituted for a conven-tional, two-dimensional pricechart a two-dimensional vari-able matrix that gives a morein-depth view of market activ-ity. The new configurationalso enabled him to deter-mine whether major playerswere initiating or respond-ing to market rallies and de-clineswhether they were

buying strength/selling weakness orwere selling strength/buying weak-ness. To a trader such informationcan be invaluable.

What was Steidlmayers innova-tion? Chances are youve seen an illustration of a bell-shaped curvealso known as a normal distributioncurve. Given a large enough numberof occurrences, bell-shaped graphsresult about 70 percent of the time.And approximately 70 percent ofthe data plotted by such a curve fallwithin one standard deviation oftheir mean.

Knowing those facts can be ex-tremely useful in understandingprice movements. Thats because iftraders assume theres a 70 percentchance that a bell-shaped distribu-tion will occur during a specified pe-riod, they can anticipate that beforethe end of that perioda tradingday, for examplecertain develop-ing formations will eventually con-form to a bell-shaped-curve pattern.

For a more fundamental under-standing of what Steidlmayer devel-oped, look at how a securitys price

ForWhom theBell Tells

By organizing

By organizing price

data via the Market

Profile technique,

you usually can spot

trading patterns

thatll give you

a statistical edge

in your investing

FIGURE 1. Type USA MKTP to see the 3-Day Market Picturefunction for the current 30-year U.S. Treasury bond future. The histogram on theright of the screen displays the most recent trading days activity at each price

Type INFO for a schedule of upcoming seminars, conferences, and events in your region. Topics rangefrom equity technical analysis to valuingmortgage-backed securities.

Type INFO for more information on the function

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data transcribe into a price distribu-tion formatinto whats usuallytermed a Market Profile. Steidlmayerdivided the trading day into 30-minute sessions. He called the 99:30a.m. session the A bracket, 9:3010the B bracket, 1010:30 the C brack-et, and so on. As markets appearedthat opened before 9 a.m., he usedlowercase letters going backwardfrom the end of the alphabet. For in-stance, 8:309 is the z bracket; 88:30is the y bracket; and so on. Next, heplotted the brackets onX and Y axes,with the X axis displaying the numberof brackets the market traded at agiven price, and the Y axis the priceitself. A days price data plotted in thisway appear in the chart below. In ad-dition to that normally distributedMarket Profile, four other standardMarket Profile distributions are likelyto occur on any given day.

The beauty of Market Profilemethodology is that if you can figureout quickly enough which profileshape is forming on any given day,then within a few hours of the mar-kets opening you can reasonablyinfer where the market will trade forthe balance of the day. This is a hugeadvantage for those trading intradaymovement, especially sell-side deal-ers, buy-side proprietary traders, andoutright speculators.

For example, to call up the MarketProfile for the past three days for the

active 30-year U.S. Trea-sury bond future, type USA MKTP (fig-ure 1). The new screenthat appears combines theGIMP (Intraday MarketPicture) and GIMH (Intra-day Market Histogram)functions onto a singlescreen. The new screendisplays the most recentthree days trading of thissecurity, as well as a volumehistogram from the mostrecent session.

The volume histogramshows how many times themarket ticked at any givenprice or, in the case of eq-uities, when actual volumeis posted intraday at thatprice. You can use it, too,as a corroborative piece ofinformation. If, for exam-ple, the volume histogramtakes on the same shape as the price profile, youhave a more in-depth wayof analyzing the days data.Moreover, the volume his-togram tells more than justvolume: it also tells wherevolume wasnt.

To put it another way,the volume histogram canspot in profile terms whatscalled low-volume areas.Whereas a price profile

would include theprice range foreach bracket, a vol-ume histogram shows howmuch volume actually gottraded at each price. Know-ing that can be extremelyhelpful to a trader, becausemarkets tend to test lightlytraded pricesmore oftenthan not rejecting such areas.

Figure 2 is a profile of Microsoft Corp. for April 20of this year. It features ateardrop-shaped profile withan early run-up followed bynormal distribution for thebalance of the day.

The accompanying volume

3. MULTIPLE- DISTRIBUTION

1. NONTREND 2. TREND DAY TREND DAY

ABE ABC LABCDEFJK ABC LABCDEFGHIJKLM ABDE HLABCDEFGHIJKLM BCDEF HJKLABFGHKLM CDEFG HJKLM

CEFG HIJKLMEFGH GHIJKL

4. TEARDROP FGH GHIJKA GHI GA HIKL GA HJKL GA IJKLM FGA IJKLM FGAB IJKLM FGABI I BDEFGABDFHGI BDEFBCDFGHI BCDEFBCDFGHI ABCDEFBCDFGHI ABCDEFBCEFG ABBCEF ABBE A

AA

Note: Neither the two different trend profilesnor the teardrop profile has to be in the priceorder shown above. For example, the trend daycould form by opening low and trending upwardduring the day, but it will always take on the basiccharacteristic of trending lower or higherthroughout the day. R.B.

StandardMarket Profiledistributions

Normal distribution

Price Range per Bracket Bracket Market Profile

4249 . . . . . . . A . . . . . . . 52 B 4752 . . . . . . . B . . . . . . . 51 B 5145 . . . . . . . C . . . . . . . 50 BCIK 4440 . . . . . . . D . . . . . . . 49 ABCIK 4246 . . . . . . . E . . . . . . . . 48 ABCFIJK 4548 . . . . . . . F . . . . . . . . 47 ABCFHJK 4541 . . . . . . . G . . . . . . . 46 ACEFHJK 4347 . . . . . . . H . . . . . . . 45 ACEFGHJK 4850 . . . . . . . I . . . . . . . . 44 ADEGHJK 4843 . . . . . . . J . . . . . . . . 43 ADEGHJK 4250 . . . . . . . K . . . . . . . 42 ADEGK

41 DG40 D

EQUITY

Bloomberg July 1998 93

Using low-volume points can there-fore help identify potential futuresupport or resistance areas. If themarket closes above its low-volumepoints during the day, for example, itmight well find support at that areathe next dayor anytime in the fu-ture that it sells back down to thatarea. If it closes below its low-volumearea, then that area, too, is a potentialresistance level anytime in the future.

With respect to the price profilesthemselves, the key to their successful

use is the ability to spot early in theday the profile shape that will likelybe formed by the end of that day. Again, if you can figure out withinthe first few hours of trading which ofthe five usual shapes is likely to formthat day, you have a leg up on howand where to play the market for therest of the day.

For example, look at the progres-sion of a profile for a typical day inthe CBOT long-bond futures con-tract. Figure 4 shows that the marketfor this security made new lows in Cbracket, but within an hourdur-ing E bracketthe market hadcome all the way back to test thehighs. That action, coupled with asomewhat normal-looking volumehistogram, was a signal that the daywas likely to be a normal distribu-tion day because no other price profile shape was likely to emergebarring a late teardrop tail. Yourtrading decision in this situation wasto sell into the high-value area, look-ing for a move down that would testback to the low-value area.

By the time of H bracket, in this ex-ample, the market had sold backdown again to test the low-valueareawhere youd likely cover yourshort position, and inasmuch as theday still had more than two hours oftrading left, you might even havegone long, looking for a move backup to the high-value area. The mar-ket then bounced in J, K, and Lbrackets to retest in the high-valuearea, only to see bracket M once againretest the low-value area (figure 5).The most important thing to learnfrom this example is that once youidentify which profile shape the mar-ket is making, several low-risk/high-reward trading plays are possible.

What follows are some other Mar-ket Profile trading strategies that haveworked well for me over the years. Ona normal profile day, for example, themarket usually clusters around themean of a profiles normal distribu-tion. The two red lines that appear onthe profile create the value area,meaning, the area where approxi-mately 70 percentthe first standarddeviationof trading takes place.

FIGURE 2. Type MSFT MKTP1 for the 1-Day Market Picture function for Microsoft Corp.

Bloomberg July 1998 95

histogram, too, is in a teardrop shapeand includes some important infor-mation not found in the price profilealone. Observe the low-volume barsbetween 93 and 93.5 that occurredduring the rally. They indicate thatthe market hardly traded these pricesrelative to all other prices traded thatday. In other words, theres a hidden

support levelthelow-volume areathatwould not be easy tosee on a bar, candle, or

point-and-figure chart. Spotting thismight well have put you in a buyframe of mind the next day had themarket sold off to this area, which infact it did. And had you bought at thislevel on April 21, you would havebeen right into the low of the day andseen the market head upward there-after and close right by the highs (figure 3).

On any given trading day, one of fivemarket profiles is likely to appear

You could categorize the value area asone that has an extensive price/timerelationship. Any price action abovethe upper red line is called the high-value area and any below the lowerred line the low-value area. Bothhigh- and low-value areas have briefprice/time relationships.

Based on traditional Market Profilebehavior, you could reasonably sup-pose that if its around midday andtheres what appears to be a normalbell-shaped curve in both the priceand volume histograms, then if youwere in the high-value area, you

oil recently has been averaging a 40-cent range each day and on thisparticular day the market has a non-trend-shaped profile and just a 15-cent range by noontime, then theshape and range of the profile aretelling you not to play today.

That kind of profile usually occursin markets trading in preholidaymode characterized by low-volumeactivity. It also often happens in thebond market the day before an em-ployment report comes out; in anagricultural commodity, the day be-fore a major crop report; in foreigncurrency markets, before a Group ofSeven meeting, and so on. You canget a good idea of how a nontrendday looks by viewing the profile of theEurodollar futures contract tradedon the Chicago Mercantile Exchangeon any typical day. The normal dis-tribution profile there looks highlycondensed, and there isnt muchmoney to be made on trades.

Heres another profilepattern you might en-counter: trend days charac-terized by an early extremepriceusually by the third bracketwith prices then trending in the op-posite direction for the bulk of theday, and a close thats usually nearthe opposite of the morning extremeprice. For instance, the market opensand establishes a range within thefirst hour. In the case of, say, an up-trend day, the profile that takesshape after the first-hour low is fol-lowed by a rally during which eachsuccessive half-hour low is higherthan the prior half-hours low: thestronger this days uptrend, the morelikely the intraday, ascending-bracketlow pattern will continue. In the caseof a downtrend day, the exact oppo-site characteristics are on view: thehigh usually is made within the firsttwo brackets, and subsequent brack-et highs are successively lower thanthe prior brackets high.

In another profile pattern, youllsometimes encounter a trend day dur-ing which two or three separate, nor-mal-looking distributions are on view,typically with single-print bracket

FIGURE 3. Type MSFT MKTP2 for the 2-Day Market Picture function for Microsoft Corp.

96 July 1998 Bloomberg

could look to sell on the assumptionthat the market will likely trade lowerbetween this point and the close.Conversely, if the market were trad-ing in the low-value area, youd lookto buy on the assumption that itwould trade higher between thispoint and the close. You can makethe assumptions based on bell-shaped-curve statistics alone.

Another strategyin this case, astrategy of inactionthat Ive usedsuccessfully is the following: if its anontrend profilea day character-ized by what appears to be a normaldistribution thats largely condensedinto the value areathen its notlikely that therell be during the day a large enough countermove tomake money. For instance, if crude

letters separating the distributions. Ifat midday you can infer by the shapeand progression of the profile that atrend day is exhibiting these charac-teristics, you can trade in the direc-tion of the trend and make money,because such days typically close op-posite their morning price extreme.Personally, Ive noticed through theyears that the bulk of these single-print moves occur middayusuallyin F or G bracket.

If the profile takes on a teardropshape, it opens up two possibilities.The first is when the teardrop formsearly in the day and prices move fair-ly quickly away from the extremefound in the first brackets. This is apreferred teardroppreferred inthe sense that once you determinethe teardrop shape has been formed,you can play the ensuing normal dis-tribution part of the teardrop. Morespecifically, if this profile is ateardrop with the early tail on thebottom, then once the market startsto distribute normally, you can lookto buy at the bottom of the curve be-cause the early tail is not typically re-visited; the opposite strategy appliesif the early tail is at the top. The sec-ond possibility, if the tail comes latein the sessionas often happenswith Standard & Poors 500-stock-index futurescomes out of leftfield and is not anticipated. This cancost you money, because if you soldhigh value or purchased low valuelate in the sessionlooking for acountermoveit may never come,and you could get hit with a latesqueeze or a liquidating sell-off. Myown rule of thumb is to never initiatea day-trading position within 60 min-utes of the close.

Last, you might want tokeep in mind that Market Pro-file methodology works espe-cially well in futures markets,in which so much trading activity getsoffset by the closing bell. This meansthat those who sold below value earlyin the day are forced to pay up laterin the day, which helps push the mar-ket from low value to high value andvice versa.

The Market Profile technique haslong been a favorite of many marketplayers. And the successes of thoseplayers suggest that bell shapes havemuch to tell about the directions offuture price moves.

Any comments? Type MAGAZINE. For reprints, type MAGZ .

Rick Bensignor is an applications specialist for Bloomberg in New York

FIGURE 4. Type USA MKTP1 . This midday picture of the June30-year U.S. Treasury bond future shows the development of a normal MarketProfile during early trading on May 27

Bloomberg July 1998 97

FIGURE 5. Type USA MKTP1 . Late in the trading day of May 27,the June 30-year U.S. Treasury bond future continued to trade around a normal-shaped distribution