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Join us for the next four weeks as Jim Dalton narrates, analyzes, and describes his trading process in current markets. The first webinar will start off with a review of the various concepts Jim employs and his hierarchy of considerations. Subsequent webinars will include Jim’s narration and discussion of the first hour, the last hour, along with discussion of the various observations that Jim uses to prepare for the next session. A wrap up webinar with a review of the month and question and answer period will conclude the series. These five webinars will be recorded and available for a limited time.

83 Educational Review Leading Up to the Break on Friday, April 4, 2014

First—an educational review followed by

Second—an analysis for Monday, April 7, 2014


Eating and living a healthy life may not be the most fun for the moment; however, as you reach age 73 and your quality of life remains fairly high the benefits become apparent. Organizing the market’s two-way continuous auction process via the Market Profile may at times appear to be misleading; however, like healthy living, the benefits become more apparent as each auction matures. The benefits of the utilizing the Profile became abundantly clear on Friday, April 4th. I want to complete a daily reconstruction beginning with Thursday, March 28th taking us through the close on Thursday, April 3rd. The two main themes we will be discussing:

  1. Momentum trading and,
  2. The exponential importance of information released via the Profile; remember, the Profile gives the market structure. Reading and analyzing structure allows us to estimate odds of auction continuation as well as make ballpark calculations regarding risk/reward.

Our educational effort continually reinforces the theme that successful trading requires a behavioral understanding of those with whom you are competing. We have not been bashful about cautioning that the odds of successful day trading are quite low; if you see the market in the same light as most other day timeframe traders you will likely continually fall within the middle of the pack.

The highest percentage of day timeframe traders are momentum traders. (This is strictly my opinion based upon having been present in the market for 40 years and having been President of J. F. Dalton Associates, a discount futures trading firm).

Let’s review what I have previously said and written regarding momentum trading. Early momentum trading is very rational. Momentum traders have a tendency to continually press a market the higher or lower it goes. However, it is in the latter stages that the market becomes irrational with traders constantly believing that there will be a greater fool to take their position when they are ready to sell.

The emotional example I have used to describe the final behavior of the momentum traders looks at race track betting; the odds at the track are determined by the pool of money (the betting pool) relative to what is bet on each horse at the start of the race. In my horse race example, traders can continually place their bets until the first horse crosses the finish line; it is very likely under this scenario that the majority of money will be bet on the winner as they see the horse out in front. Favorable odds will be almost nonexistent; in other words, the risk/reward will be totally out of line. What happens when the horse stumbles just a few lengths from the finish line; the risk taken (the bet) was exponential relative to the potential reward (splitting the winnings with the majority who bet on the leading horse).

Reconstruction of Risk as Viewed through the Market Profile

Review—analysis of each day’s market begins with identifying market direction. What we want to determine is, in what direction was the market attempting to auction and, how would you rate the auction’s attempt to move in that direction. A successful auction will be accompanied by solid relative volume (relative to average volume over the past several weeks). Additionally, there will be some elongation to the Profile. By elongation we mean that the POC migrated with the direction of the auction and the Profile never got overly wide, reading from left to right. The S&Ps, for example, trade during fifteen thirty minute periods; a healthy Profile (meaning having good odds of continuation) will generally be no more than 5 or 6 periods wide at any price level. (This is not a science and there are many nuances that have to be considered; however, this will serve to help make the following analysis understandable.)

Thursday, March 27th


Thursday delivered a balanced trading day; on Friday March 28th the market began to trade out of balance to the upside. We will begin our analysis with Friday.

Friday, March 28th:


  1. Attempted direction was up.
  2. Value was clearly higher relative to Thursday (positive). Remember, we trade value not price.
  3. The low on March 28th was very poor showing no excess (negative); we need to carry this information forward. At this point we are seeing a single negative data point.

Monday, March 31st:


  1. Attempted direction is up.
  2. Value clearly higher (positive).
  3. With attempted direction up there is no elongation; the POC is twelve periods wide. This is very negative and makes the second cautionary data point. This information is carried forward. Had there been a healthy combination of day, short-term, and intermediate or longer-term buying, the Profile would have been elongated. Momentum traders are continuing to press the market higher.
  4. Overall volume was considered to be below average; this is another negative data point to be carried forward. This also confirms our assessment that longer-term, more serious timeframes or investors were not overly interested in the rally.

Tuesday, April 1st:


  1. Attempted direction is up.
  2. Value, once again, is clearly higher (positive).
  3. The POC or fairest price at which business was being conducted remains within the lower portion of the Profile; this is extremely negative.
  4. Because of the POC there is no elongation recorded for this day (negative).

Why does the POC remain lower and why is there no elongation—while the momentum traders are continuing to press the market, smarter money with a slightly longer timeframe are selling into them. (I can’t be positive of the timeframe so I have taken a conservative approach by assuming that the timeframe is only slightly longer.)

Wednesday, April 2nd and Thursday, April 3rd see the market come into short-term balance:


Wednesday, April 2nd saw:

  1. A gap higher (positive).
  2. Higher value (positive).
  3. A POC or fairest price that remained below the center of the range (negative).
  4. Low relative volume (negative).
  5. No elongation (negative).

Once again momentum traders closed the market on the highs.

Thursday saw a balancing day as the market awaited the monthly Jobs Report on the first Friday of the month, April 4th.

Following Wednesday’s settle I wrote that there was the potential for an excess high to the long-term auction, which could be followed by a meaningful break or liquidation.  That didn’t happen as Thursday saw the market balance.

Friday saw the break that I was mentally preparing for coming into Thursday; go back and review the negative data points starting with Friday March 28th. The cumulative negative data points led me to see an exponential risk to being long the market, and to be prepared for the liquidation break when it arrived.

The overall lack of elongation and low volume were the most telling data points. I view the Market Profile as a real-time, constantly evolving, data base. The market distributes its constant flow of bids and offers via a continuous two-way auction process; the Market Profile records these auctions and allows us to see the market’s structure. A graphic, which is what the Profile is, allows us to see several important pieces of information combined together. It is easier to interpret and analyze the market’s two-way auction process through the composite view of the Market Profile.

Cognitive Dissonance—You will remember that one of the signs of a mature trader is the ability to keep two opposing thoughts in focus. As I saw the continual accumulation of data building I was still able to focus on what was occurring on a day timeframe basis while also keeping in mind the building odds of a liquidation break. To protect against the negative effects of cognitive dissonance, your short-term and day trading focus should have been on developing value; this would have allowed you to stay with the upside auction and avoid leaning into the potential liquidation break before the auction completed itself.

Preparation for Monday, April 7th:

  1. The all-time high was made during the electronic session. As we have written so often, the odds are against the all-time high being established in the electronic market. Some will question the importance of a single tick; I don’t. If there were serious sellers I doubt that Friday’s high would have been so closely related to a similar high.
  2. Friday’s volume, particularly for the range, was very low; this is usually a sign of liquidation rather than a more potent combination of liquidation and new money selling. If a lasting high is to occur I would have expected to see meaningful, new innovator and longer-term selling as evidenced by volume.
  3. Friday’s Profile was too elongated; this is usually a sign of liquidation rather than liquidation and the more important new money selling.
  4. Liquidation can continuation; however, remain open to a rally.
  5. See short-term reference below:


My immediate focus for Monday morning is on Friday’s short-term balance:

  1. Lower developing value, relative to Friday’s lower distribution, targets the Friday, March 28th poor low around the 1845 level.
  2. Higher developing value allows the market to begin another attempt to trade back to the all-time highs.

71 What Timeframe Is Dominating

Markets in Profile, Profiting from the Auction Process, describes 5 trader timeframes; for the purpose of this article we will segment them into to two categories. First we will consider the day and short-term trader with the short-term comprising up to approximately 10 days. There is no magic in 10 days, it is simply an approximation. We will refer to this group as short-term traders. The second group consisting of intermediate and long-term traders we will label as all others.

The important distinction is the way each of these timeframes thinks and acts. The short term traders, which make up the majority of traders that we interact with every day, are more mechanical and fickle.  I use the term mechanical to describe their more exacting entry and exit levels; these levels are usually very identifiable and visual.

We describe the short term as fickle because their emotions, which can change very quickly, constantly lead them too far in the direction of the current auction. The initial auction can be initiated by either short-term traders or the timeframe I am calling “all others”; no matter who initiated the auction, short-term traders quickly “pile on” and then continue to press the trade. The longer the timeframe, the “stickier” the trade. By “sticky” I mean that their intention is to hold the trade considerably longer than those of shorter timeframes. The longer the timeframe, the harder it is to identify exactly where they were the most active as their size is too big to execute at the more identifiable references.

Learning to identify which timeframes are dominating the market is “scalable”. By scalable I mean that the more you begin to be increasingly aware of the importance of the different timeframes and familiar with their individual behaviors, the more your knowledge base will expand; as your knowledge base expands, internalization can begin. Let’s continue via examples.

E-Mini S&P December Contract 2012


I have constantly labeled 1400 as an important psychological level. In Daniel Kahneman’s book, Thinking, Fast and Slow, he discusses anchors. In this case 1400 is an anchor. Other similar types of anchors are daily highs and lows, overnight highs and lows, prominent POCs, even numbers, balance area highs and lows, etc. In his book Kahneman demonstrates how a screen saver on an irrelevant computer can affect your willingness to help strangers without you even being aware of it. His point is, are we really free of the subconscious influences that surround us day in and day out. Do we really know how an anchor guides our thinking; are we even aware that an anchor has been set.  Kahneman goes on to say, “…you do not know how it guides and constrains your thinking, because you cannot imagine how you would have thought if the anchor had been different or not there at all.”

I advise day and short-term traders to prepare for each trading session by reviewing monthly, weekly, and daily bar charts along with the daily Profiles. The purpose behind this is so that you will be aware of references—anchors—that are longer-term in nature. It is at these levels that significant change can occur if the longer timeframe becomes active. Short-term traders that are unaware of these anchors often get run over and never fully appreciate what happened. If you don’t know what happened it is difficult to avoid the same mistake next time.

The most salient point of this article is that anchors are real; however, what is a short-term anchor may not even be seen or recognized by the next longer timeframe. Longer timeframe traders are unlikely to care or even be aware of an overnight high or low yet these same anchors are very important to short-term traders. As we review the examples, continue to focus on the influence and behavior around anchors and ask yourself, “Who really cares about what happens around this reference or anchor.” Once you enter this frame of mind you will begin to get deeper and deeper inside the head of those you are competing with. This understanding will help you develop a feel for what is transpiring.

In the E-Mini S&P example shown above we see price approach or trade slightly through the 1400 level on five occasions before there is acceptance below this anchor on November 7, 2012. Had there been longer timeframe buying interest on the original break down to 1400, it is unlikely that price would have continued to return to that level. Long-term money usually has more impact. Also, when they are active, the shorter timeframes tend to pile on helping to move price away from the reference decisively for longer periods of time. As the auction approached the psychological 1400 level, price only briefly moved higher from 1400. The odds were increasing that 1400 would be taken out. In other words, the 1400 level was gaining acceptance as more time was spent revisiting this price level. Trading Education Article 68[1] discusses “acceptance”. It was clear that acceptance was occurring at the 1400 level.

Traders do what works until it doesn’t work anymore” is a phrase that you have heard me say on several occasions. This is what was occurring in the above example; short term traders were buying dips at the 1400 level, however they were getting less and less on each successive bounce. Finally, it didn’t work anymore.

Cognitive dissonance is the anxiety we feel when we are experiencing two simultaneous conflicting thoughts or ideas. [This topic was covered in our Timeframe Cognitive Dissonance webinar[2] March 24, 2011.] The positive side of cognitive dissonance enables experienced traders to hold two opposing views—one short-term and the other an opposing developing longer-term view. Both views eventually played out in the above example. Next, we will apply similar logic to examine the break below 1400 and understand why my pre-market updates kept cautioning that the break was suspect.

E-Mini S&P December Contract 2012

71bOn November 7th price finally found acceptance below the 1400 level. Twice on the 7th and once on the 8th, the S&P’s rallied to test the 1400 level. Had the break been caused by new longer term “sticky” money it is unlikely that price would have revisited the 1400 breakout level twice on the 7th and again on the morning of 8th. What this suggested to me was that short term liquidation was underway; however, it wasn’t the more potent combination of liquidation and new money selling. In other words, the break was orchestrated by short-term traders.

What do these observations suggest about the future? We can anticipate liquidation combined with short term momentum traders pressing the downside. Additionally, we know from experience that momentum traders tend to trade to extremes. Recall my racetrack example where bettors can place bets until the horse crosses the finish line. Most of the money is on the winner; however, the payoff is very small and the risk very large. If the horse breaks its leg close to the finish line all the bettors piling on lose all—with a small payout if the horse wins to be split amongst the large betting pool. The odds are that with short term liquidation and momentum trading, the market will get too short.  Let’s go to our final example.

E-Mini S&P December Contract 201271c

The short-term momentum traders did what they do so often; they took the market to an extreme. Below is an email I wrote to a client on November 19th.


Hello; looks like the shorts are caught. This is a good time to go back and review the pre-market updates from the past several days as this is a very important opportunity to gain a deeper understanding for future longer-term trading. This is where longer-term traders get trapped. The real skill is appreciating what timeframes are participating; additionally, this is a good time to better understand the laggards.

It was certainly a lot easier to narrate this market through the pre-market updates and to write about it for this article than it was to trade it. However, being able to stay out of financial trouble and to trade a market like this starts with understanding who is dominating the market—in this case it was short-term traders. Had the break been a combination of long liquidation and new money selling by the longer timeframes, the odds are that the correction would still be underway.

My assessment of the low odds for continuation was based upon the mechanical nature of the way the market went down. Continually making your own assessment of the odds of continuation will help protect you from focusing too heavily on price.


Note that this discussion contains no references to indicators and very specific price levels; it transcends exacting information and requires that you engage in a broader market perspective. To understand the big picture while also participating in the short term is the hallmark of a professional trader. Developing this level of market understanding is not natural for most of us; ambiguous and often conflicting information is rarely appreciated. However, armed with this awareness you have the ability to separate yourself from your competitors who are primarily focused on price and the ‘shock and awe’ that is often brings to the auction process.