What I’ve Learned From Jim Dalton and Market Profile Theory

Brett N. Steenbarger, Ph.D.


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“There is nothing so practical as a good theory,” psychologist Kurt Lewin once commented.  A theory helps us organize our perceptions; it helps us make sense of the world.  The purpose of science is not just to predict, but also to explain.  We can predict when the sun will rise in the morning, but that doesn’t mean we understand a damn thing about the solar system.  Theories are practical, because they help us understand markets.  Too many traders focus on prediction and fail to understand why markets behave as they do.

Market Profile is a theory and, like all good theories, it is based upon an analogy.  Analogies transform what we don’t know into a framework that is more known.  If I were to develop a theory of people’s responses to losing trades based upon research into what we know about traumatic stress, that might be quite practical.  The techniques from the trauma literature might be useful in helping people manage the stress of drawdowns.  As we learn more, we can refine our theories and this can improve our practice.  Perhaps I identify that large wins shake people up as much as large losses.  The techniques from PTSD therapy might actually be helpful in enabling traders to psychologically manage their upside!

The analogy at the heart of Market Profile theory is that markets are auction processes, not so unlike eBay auctions.  We have buyers, we have sellers, we have buyers willing to pay the “buy it now” price, we have sellers willing to accept any bids, and we have buyers and sellers willing to name their prices.  It is the interplay of these eager and patient participants that ultimately determines price movement over time.  By tracking how price and volume behave at particular price levels, we can gain insight into whether buyers or sellers have taken the upper hand.

An important aspect of Market Profile theory is that it pushes us to view market behavior from the bottom up, not just from the top down.  Many traders taking a “macro” perspective attempt to predict market behavior from what is going on in the economy or from monetary or geopolitical developments.  Market Profile takes each period of time, each level of price, and each unit of volume and infers the buying and selling of participants here and now.

This is what is unique to Market Profile:  it identifies; it does not predict.  It is not a crystal ball; it is a weather vane.  If you’re about to parachute into markets, it helps to know not only the weather forecast but the wind direction and speed here and now.

There is one other important strength to Market Profile theory: it places market movement into context.  We might break out to a new high or low in price, but that breakout might be occurring within the context of a longer-term range.  Conversely, we could be breaking out of a longer-term range, making the short-term price action especially important.  Market Profile encourages us to view markets across multiple time frames, so that we can more readily identify when we’re achieving new levels of value or merely probing upper and lower levels of an existing value area.

Where is value located?  How is value shifting over time?  How are moves outside of the value area being accepted or rejected?  These are some of the questions that make Market Profile a practical theory.  When we view markets as auction processes, we can understand why markets behave as they do.  Having a handle on those whys can make us more confident traders.

If we trade well, if we trade with understanding, we’ll be most likely to sustain a positive trading psychology.  Too many people hope to make money by working on their psyches.  The truth is that trading with understanding gives us the mastery needed for a positive mindframe.

One last observation:  I’ve learned all these things from Jim Dalton.  He is more than a trader and more than a theoretician.  He is a true teacher.  When I ran a training program for new traders in Chicago, there was only one required textbook, and it was Jim’s Mind Over Markets.  It’s not about finding setups or predicting the next Fed meeting or market trend.  It’s about understanding what the hell markets are doing and why they’re doing it.

If you’re trading without a theory, you’re trading without understanding.  That’s the most impractical option of all.

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