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Value Area
The market is composed of time, price, and volume. Each day the market --
attempting to accommodate trade -- develops a price range delineated by the
high and low, and usually develops a value area. Volume is generated by the
interaction of time and price.
During each trading session a value area is usually established as the
market uses price-probes which move, alternatively, too high and too low in
order to create TPO's that seek the
trading activity of market participants. These
price-probes have the following
impact upon the quantity supplied and demanded: the quantity supplied is
stimulated and the quantity demanded is dampened as price rotates higher,
while price rotation lower has the opposite effect. In this way, price
consolidation is promoted, and a value area is established: that is, time
and price produce volume, and volume validates value.
The Chicago Board of Trade is the first futures exchange that released for
all of its markets, the contract volume conducted at each tick of the day's
price range; additionally, the Chicago Mercantile Exchange (hereinafter,
"CME") began to release such information in late-1989. Since many market
profile analyses require such volume information, they can be conducted for
only these markets.
There are two types of value area.
The calculation of volume value area requires the contract volume conducted
at each tick of the day's price range; in the chart below,
volume value area
is represented by the thin rectangle appearing to the right of the profile
graphic .
To calculate volume value area, the
highest volume tick is identified; beginning with the contract volume at
that tick, the volume at the tick above or below it with the greater volume
is added. This process is continued, until the total equals at least 70% of
the day's contract volume.
By comparison, the calculation of
TPO value area
adds TPO's using an analogous algorithm; as a result, it is able to be
calculated for any market. In the chart below, TPO value area is depicted by the
thin dashed rectangle appearing to the right of the profile graphic.
To calculate TPO value area, the
highest time-price tick (that is, the one with the most TPO's) is identified;
beginning with the number of TPO's at that tick, the number of TPO's at the
tick above or below it with the greater number of TPO's is added. This
process is continued, until the total equals at least 70% of the total
number of TPO's comprising the graphic.
The following market behavior is easily-observed. When a market opens within
the range of the previous day's value area, the first time the high or low
of that value area is approached, it will be resistance or support. When a
market opens outside of the previous day's value area, it will be support or
resistance the first time the market attempts to penetrate it; if value is
penetrated, there is a high probability that price will move to the other
side of the range. The extensive use of market profile allows such behavior
to be observed.
As perceived by Peter Steidlmayer, trading opportunity is predicated upon
the fact that -- under the prevailing market conditions -- the current price
can diverge from value. Having identified the value area, one can take
advantage of a divergence of price and value, since either a divergent price
will move back to value, or value will move to the current price. That is,
the key to market opportunity is knowing when current price diverges from
value, and correctly judging whether price will move to value, or value to
price.
CTI
Code, Contract Volume, Tick Volume, and TPO Count
The CBOT and CME stratify market
participants into four categories that are designated by customer
trade indicator (i.e., "CTI") codes.
CTI1 designates local floor traders,
day-time-frame traders
CTI2 designates commercial clearing
members, other-time-frame traders
CTI3 designates clearing members
filling orders for other members or for non-clearing commercial traders, and
CTI4 designates clearing members
filling orders for the public, or for any other type of customer.
Market profile considers CTI1 participants to be day-time-frame traders, and
CTI2 participants to be other-time-frame traders. It is recognized, however,
that day-time-frame traders sometime conduct CTI2 business, and that
other-time-frame traders sometime conduct CTI1 business.
In the chart below, a cursor is positioned at 5762. The following
information is displayed in the window that appears below the graphic: 1)
VAH, the high tick of the volume value area, 2) VAL, the low tick of the
volume value area, 3) VOL, the contract volume in value, 4) CTI2, the
percent of contract volume conducted by commercial clearing members in
value, and 5) TPO, the time/price opportunity count.
Calculation of the first four of
these items requires contract volume at each tick. The CBOT releases such
data hourly during the day trading session, as well as at approximately
17:00 and 20:00 hours Central Time. The CME releases such data prior to the
open of the day session. At some time in the future, such data will be
available in real-time.
Additionally, on-the-minute tick volume is available for all markets: it is
the distribution of the frequency at which a market trades at each tick. In
the case of markets for which contract volume is not available, tick volume
may be used with caution as a proxy; Figure 25 compares CBOT volume with
tick volume.
The highest time-price tick is the tick at which trading occurred during the
most 1/2-hour periods; in that sense, it is the fairest price of the trading
session. The time/price opportunity count (hereinafter, "TPO count") is
concerned with the participation of other-time-frame traders in value, and
reflects their willingness to buy at a higher price, or to sell at a lower
price; the TPO count in Figure 30 is 18-over-34. The TPO count is defined as
the number of TPO's above and below the highest time-price tick nearest the
center of the day's price range, excluding single-print ticks at the top
and/or bottom of the graphic. On the one hand, an evenly-balanced TPO count
suggests that there is no willingness to accept a divergent price. On the
other hand, an imbalance in value, as reflected by the TPO count, suggests
that price will move. Therefore,
it is important to watch for any small incremental change in the value area
because this change can indicate the willingness of traders to buy or sell
at a higher or lower price. The market is more vulnerable to volatility when
there is less volume to give stability. Consequently, the market has a
tendency to accept a divergent price on the short side of the
distribution...the side with less volume (Chicago Board of Trade, CBOT
Market Profile, Chicago, IL, 1984, page 51).
As depicted in Figure 30, an unbalanced TPO count above the highest
time-price tick indicates a propensity of other-time-frame traders to accept
a divergent price above this level, if price were to probe there; that is,
since other-time-frame traders have exhibited a greater willingness to buy
than to sell, they may be willing to buy at a higher price. Similarly, an
unbalanced TPO count below the highest time-price tick suggests a
willingness to sell at a lower price.
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