Previously, we considered the manner in which the market utilizes price probes and rotation during the

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1 Stocks & Commodities V. 6:3 ( ): Market profile Part 4 by Thomas Drinka, Ph.D. and Robert L. McNutt Market profile Part 4 by Thomas Drinka, Ph.D. and Robert L. McNutt Previously, we considered the manner in which the market utilizes price probes and rotation during the trading day to promote trade. Depending on the response of other-time-frame traders, these probes result in one of six possible daily profiles. Similarly, market rotations occur from one day to the next and over the longer term. The primary purpose of this article is to demonstrate how the Chicago Board of Trade's daily volume summary known as the Liquidity Data Bank and a long-term auction activity chart can be utilized to analyze rotations that occur day to day and over the longer term. The Liquidity Data Bank is transmitted several hours after the close and shows the volume of every contract traded at the exchange. These data are taken from the second Board of Trade Clearing Corporation reconciliation, which includes 70%-80% of all CBOT cleared transactions. Figure 1 is a Market Profile, a 30-minute bar chart and the Liquidity Data Bank volume summary of CBOT September 1987 U.S. Treasury bond futures for August 20, The volume summary's horizontal bars are the percent of total daily contract volume conducted at each price traded within the daily price range of the contract. The dark portion of the horizontal bar is the percent of each total daily contract volume conducted by commercial clearing members (known as CTI2 in the Profile). At the time of this writing, the activity of other-time-frame traders at the Chicago Board of Trade usually ranges between 10% and 60% of total volume. The greater the percentage of total daily contract volume that commercial clearing members represent, the greater is the potential for them to change the market's structure. Article Text 1

3 Stocks & Commodities V. 6:3 ( ): Market profile Part 4 by Thomas Drinka, Ph.D. and Robert L. McNutt In Figure 2, we positioned out computer's cursor over 8913 and a box appears below the volume summary, showing that 8.1 % of total daily contract volume occurred at that price and commercial clearing members accounted for 12.6% of the contract volume at that price. Figure 3 presents the percent of total daily contract volume conducted at each price traded within the daily price range, as well at the percent of CTI2 volume at each price. The activity of commercial clearing members ranged from 0.7% of total daily contract volume at the price of 8924, to 24.6% at The total CTI2 participation for the day within the Value Area was 14.10% (as seen in the box below the Profile in Figure 2). Using the CTI codes in this way after the trading session, the participation of the other-time-frame traders can be observed. Auction activity chart As explained in Part 3 of this series (February 1988), market activity displayed on a long-term auction activity chart (Figure 4a) is summarized from the center columns outward. Initiating activity appears closest to the center, since such activity is stronger than responsive activity. The columns are arranged from the center outward to show extremes, range extensions and TPO count, in that order. The reasons for this arrangement are twofold. First, during the trading session, extremes usually form first, range extensions form next, and the TPO count takes the longest to develop. Second, extremes are stronger activity than range extensions, which are, in turn, stronger than TPO count. A long-term auction chart shows the strength or weakness of the market as it moves through time and allows one to judge whether a market trend is gaining strength, waning or ending. In analyzing long-term rotations on a long-term auction chart, market activity is said to proceed from "imbalance" to "balance" to "test day" to "imbalance" and so on. Consider the market for CBOT September 1987 U.S. Treasury bond futures. For approximately one month ending July 16, the market had been balanced; that is, the long-time-frame traders had engaged in nearly equal instances of buying and selling activity. Then, July 16 was a test day. A test day can be a neutral day, a nontrend day or a failed trend day that develops into a running profile. (See Part 1, December 1987, for a complete description of these days.) July 16 was a neutral day. From July 16 through July 20, the market was struggling to break out of balance. July 21 was another neutral day and the market finally moved sharply lower on the 22nd. The long-term auction activity chart (Figure 4a) of that market for July 21 through August 3, 1987 shows that the daily Value Areas ranged from a high of 9123 on July 21 to a low of 8810 on August 3. From July 22 through July 30, the daily Value Areas ranged from a high of 9016 on the 22nd to a low of 8908 on the 30th. Additionally, the market was imbalanced. That is, other-time-frame traders were primarily engaged in selling. During that seven-day period, there were 13 instances of initiative selling activity (shown as dark boxes on the left side of Figure 4a), compared to only five instances of buying activity (three of them initiating and shown on the right side of Figure 4b as dark boxes, and two of them responsive and shown as open boxes). Such activity suggests a continuation of the long-term selling. Subjective analysis From July 29 to July 30, value moved lower. The Value Area on July 29 ranged from 8915 to 8923, while the Value Area on the 30th ranged from 8908 to 8922 (Figure 5). July 30 was a neutral day, finishing high in its range. "Subjective analysis" of the volume and commercial activity indicated whether Article Text 2

7 Stocks & Commodities V. 6:3 ( ): Market profile Part 4 by Thomas Drinka, Ph.D. and Robert L. McNutt the selling of the 30th would continue on the 31st. This "volume analysis" involves five individual analyses, each of which provides an expectation of "continuation" or "change" of market activity. In this situation, continuation would be the market moving lower. Analysis 1: Total contract volume on July 30 was 460,568 compared with 338,638 on the 29th The higher volume on July 30 reflects greater trade facilitation at lower value and suggests continuation. Analysis 2: Compare total contract volumes on the extremes. Here, the extremes include the lowest and highest three-to-five ticks of the trading session. The price range (excluding the night session) is 8905 through Aggregate contract volumes in the bottom three, four and five ticks are 15,736, 28,980 and 48,600, respectively. Contract volumes in the top three, four and five ticks are 22,088, 22,974, and 25,554, respectively. This analysis suggest continuation, since higher volume occurred at the low extremes. Analysis 3: As seen in Figure 6, the middle of the price range for the day session was at 8918 and Contract volume of the day session in the bottom half of the Profile exceeded 67% of total contract volume. This suggests the market would have to move lower to attract sufficient buying to dampen the selling that was conducted through the 30th. That is, continuation lower seems likely. Analysis 4: The Volume Value Area on July 29 was nine ticks wide, while the Volume Value Area on the 30th was 15 ticks wide. Furthermore, value on the 30th was lower than on the 29th. Continuation is suggested, since greater facilitation of trade occurred on the 30th at lower value. Under this analysis, the position of the Volume Value Area (i.e., 8908 to 8922) is compared to the position of the TPO Value Area (i.e., 8906 to 8928 in the day session). If most volume as reflected by the Volume Value Area is conducted on the high (or low) side of the TPO Value Area, price would be expected to move higher (or lower) the following day. Since the Volume Value Area on the 30th is on the low side of the TPO Value Area, we'd expect the price to move lower the following day. Commercial activity Two considerations are relevant. First, in the U.S. Treasury bond futures market, CTI2 participation in value usually approximates 13%. On July 30, CTI2 traders accounted for 15.4%. This high participation suggests continuation, since the activity of commercial clearing members was facilitated at lower value. Secondly, the "normal" activity of other-time-frame traders is to fade the extremes of the daily price range. On July 30, the Volume Value Area ranged from 8908 to CTI2 participation during the day session averaged 15.5% above value, 15.4% within value and 9.5% below value. This activity suggests continuation because the other-time-frame traders conducted more selling above the day's Value Area than buying below, assuming they were fading the day's highs and lows as they typically do. Conclusions This subjective analysis suggests continuation of the downtrend. The five volume analyses suggest continuation down and both analyses of commercial activity suggest continuation. As already noted, initiating activity by other-time-frame traders is a stronger market participation than responsive activity. Additionally, initiating buying and selling are usually faster activities than responsive Article Text 3

8 FIGURE 6

9 Stocks & Commodities V. 6:3 ( ): Market profile Part 4 by Thomas Drinka, Ph.D. and Robert L. McNutt buying and selling. Having concluded that selling would continue into July 31, one would also conclude that this selling would be initiating, since it would occur within or below the Value Area of July 30. Thus, if selling activity were observed on the following day, one would have to react quickly. July 31 actually began with initiative buying on the extreme followed by initiative buying range extension that was terminated in the "D" time period. The TPO count reflected initiative selling. Thus, other-time-frame traders were buying early in the day, but selling was too strong to allow the market to move higher. Finally, on August 3, the next trading day, the strong selling pressure that had been observed during the imbalanced period of July 22 through the July 30 prevailed, and the market moved sharply lower. Thomas Drinka is an associate professor in the Department of Agriculture at Western Illinois University, Macomb, IL 61455, (309) Robert McNutt is a research and development assistant at Commodity Quote Graphics, Glenwood Springs, CO 81602, (800) Western Illinois University is the first university to teach the CBOT Market Profile and Liquidity Data Bank as part of its curriculum. Figures in this article were generated by CQG's System One, which has been donated to the Department of Agriculture at Western Illinois University. The authors wish to thank the Chicago Board of Trade and the Chicago Mercantile Exchange, which have waived exchange fees associated with this price quotation service and the Market Logic School for reviewing a preliminary draft of this article. CBOT Market Profile and Liquidity Data Bank are copyrighted by the Board of Trade of the City of Chicago References Chicago Board of Trade. CBOT Market Profile, Market Logic Schools. Transcript of Educational Program II. Chicago: May 9-12, 1987 and September 12-15, Steidedlmayer, J. Peter and Shera Buyer. Taking the Data Forward. Chicago: Market Logic, Inc., Steidlmayer, J. Peter and Kevin Koy. Markets & Market Logic. Chicago: Porcupine Press, Figures 4

The market is composed of time, price and volume. Each day, the market in attempting to facilitate

Market Profile Part 2 by Thomas P. Drinka, Ph.D. and Robert L. McNutt The market is composed of time, price and volume. Each day, the market in attempting to facilitate trade develops a price range delineated