Yesterday I posed 3 problems that those using Wykcoff had to overcome:
- How do we define market direction?
- How do we determine whether volume for any given period is net selling or net buying?
- How do we overcome volume cyclical patterns (e.g the pattern in financial futures) or sessional patterns (e.g. the pattern found in intra-day ES data)?
The answers to the first two questions can be answered using Market Delta; the answer to the third question lies in normalized volume.
To answer the question how do we best determine market direction, we need to first consider what is the best indicator of acceptance of a given price? Remember there are no issues where the market makes a higher high, higher low and higher close. In this case, the market’s direction is ‘up’. It is where there is a discrepancy between the extremes and the close that problems arise e.g. a lower close with higher highs and higher lows or where you have an outside day.
Our work confirms that the best indicator of direction is the Market Profile’s Point of Control. This is the mode of a day’s profile and represents the price where 70% of the trading has taken place. Figure 1 shows the idea for a 30 minute chart – you can use this idea for any timeframe.
FIGURE 1 POC
Market Delta’s Delta Module will tell us if a time period’s volume is net buying or net selling. In Figure 2, the Figure below each time period’s range shows the difference between buying and selling volume.
FIGURE 2 Net Volume
To see how this works, take a look at the 3:00 PM bar. We made a higher high and higher low (lower close see FIGURE 3) on reduced net buying. The POC was slightly higher. So the higher high was a fakeout and a sell signal – market direction up on low volume. Looking at the normalized volume chart we see a DOJI bar with normalized volume that was at least normal. The normalized volume is the grey coloured histogram. The green and red colours on the histogram represent the Delta relationships.
So the normalized volume chart shows the market moving higher on at least normal volume and smaller range – this is a signal of a possible reversal.
Wyckoff’s volume ideas are now mainstream technical analysis, for example:
- New highs or lows should be accompanied by normal to moderately higher volume.
- Excessive volume on new highs suggests a possible climax.
- Less than normal volume suggests a false breakout (fake out).
I define normal as being within 70% of the mode; moderately higher as being above the mode (effectively 70% + 12.5%) and excessively high as the rest of the volume above the mode. I use the same process as Steidlmayer when he calculates the Value Area.
One question I am always asked is: how do you calculate normalized volume?
It’s a bit of a pain. If you trade only the S&P, it’s much easier to subscribe to www.marketvolume.com. For other instruments, I work out a sample every 12 months for the next 12 months. The process for daily data:
- Start 2 weeks into the roll-over month and end on the last trading day before the roll-over month. For example, for March 08 active month, start in Jan 08 and end Feb 2008.
- Work out the average volume for every corresponding day of week e.g. all Monday’s in 2007 that meet condition 1.
- The averages represent your normalized volume for Monday, Tuesday etc.
- Make sure you align and average the major news event releases.
As I said, the calculation is a pain – which is the reason I outsource the work.
When I turned to analysing volume with market direction and range, I find that my bottom was considerably improved.
Outlook for ES Dec 21: Normalized Volume shows normal volume with a DOJI bar. If this occurred at an extreme, I’d look for a change of direction; but where it occurred yesterday, I would place little value on the DOJI. Market Delta shows normal BUYING volume with a lower POC. I interpret this as a poor attempt to head South. Hence I’d be looking for higher prices tonight.
Futures are calling ES 9 points higher. As long as the open-gap is no less than 4 points, the ideal buy scenario is a failure to close the gap in the 1st 90 mins. One buy setup would be to buy the breakout of the 90 minute range provided the 90 min range is not more than 15 points. The stop would be below the Volume POC (1465). This is the easiest scenario when writing because the parameters are so clear.
It’s not the one I’d prefer. My preferred buy setup is to look for a pullback into 50% of the gap and provided the volume at the 50% or so is below normal, I’d look to buy on a 5-min setup that takes place between the hour and 90 minutes.