Value Area
A good indication of trend continuation lies in observing value area placement. If a series of value areas is moving in a clear direction through time, then the new price levels are being accepted and the trend is finding acceptance. If value areas begin to overlap or move in the opposite direction of the trend, then chances are good that the trend is slowing and beginning to balance.
Openings Within Value
Acceptance
When a market opens within value and is accepted (overlapping TPOs signify value, or acceptance), this generally indicates that the market is in balance and that market sentiment has not changed dramatically from the previous day. Trade risk and opportunity are both relatively low. The day's range usually will be contained within the previous day's range or overlap one of the previous day's extremes slightly to one side. When a market opens and builds value within the previous day's value area, it is possible-very early on-to make a rough estimate of the developing day's range potential.
Before we proceed to an actual example, let us first present a few guidelines for estimating range potential:
1. Determine the opening's relationship to the previous day's value and range.
2. If an estimate is possible (acceptance in range), identify the initial extreme that has the greatest potential to hold. Then superimpose the length of the previous day's range to arrive at an estimate.
3. Allow roughly 10 percent in either direction, recognizing that this is just an estimate, not a prediction.
4. As the day develops, early extremes are erased or confirmed and buyer or seller directional conviction becomes more evident, adjust the estimate if necessary.
Rejection (Break-out)
When a market opens within the previous day's value area and drives out during the first half-hour of trade (does not build double TPOs to signify acceptance within value), the market could be breaking out of balance. If the early break-out drives price completely beyond the limits of the previous day's range, then both risk and opportunity are high and range estimation is unlimited in the direction of the initiative drive
Open Outside of Value but Within Range
Acceptance
A market that opens outside of the previous day's value area but within range is not as balanced as an open within value, but the market is still "bouncing on flat pavement." Similarly, a day that opens within range but outside of value will generally produce a range that is similar to the previous day, but overlapping to one side. The risk on this type of day is slightly greater than the previous open relationship, but the opportunity is greater as well. Openings outside of value but within range indicate a market slightly out of balance and usually result in value that overlaps to one side.
The method for range estimation used for "Openings Within Value" applies equally well here. The resulting range development will usually extend beyond the previous day's high or low, for the market opens closer to one of the previous day's extremes.
Rejection (Break-out)
On this type of day, the market opens above or below the previous day's value area but still within the previous day's range. If the market subsequently breaks-out beyond the extremes of the previous day's range, then the market is coming out of balance and range potential is unlimited in the direction of the break-out.
Open Outside of Range
Acceptance
When a market opens outside of the previous day's range and is accepted, conditions have changed and the market is out of balance. At this point, one of two scenarios are possible:
(1) the market will continue to drive in the direction of the break-out;
(2) the market will begin to auction back and forth at the new price levels.
In both cases, as long as price does not return to the previous day's range, the market has accepted the break-out.
The greatest imbalance occurs in the first scenario, when a market opens beyond the previous day's range and continues in the direction of the break-out. The movement away from value is initiative and the other timeframe often moves price with great speed and conviction. Range potential is unlimited in the direction of the break-out, and a trend day is usually the result.
This type of open offers the greatest potential to the trader who recognizes the opportunity early and positions him- or herself with the break-out. However, it also poses the greatest risk to the trader who at-tempts to trade against the driving initiative auction. Potential range development is unlimited and risk is extremely high for the trader who is positioned the wrong way. Accompanied by increased risk, however, is also the potential for greater opportunity. An open outside of range offers the potential for a highly successful and profitable trade if market direction is detected early.
Rejection
When a market opens beyond the previous day's range and is rejected back into the range, the potential for a dynamic price move in the direction opposite to the opening break-out is set into motion. A typical example would be a market that opens too far above the previous day's high, fails to follow through, and is quickly "corrected" by responsive sellers who return price to previously accepted value. The day's range potential is still unlimited, for the market opened out of balance and could move significantly in the opposite direction.
Summary
Simply keeping track of where the market opens in relation to the previous day's range and value area is valuable market-generated information. A market that opens within value is generally in balance and awaiting new information. A market that opens outside of value is out of balance, and carries with it greater opportunity and risk. By synthesizing the opening's relationship to the previous day with other market-generated elements, such as the opening type and initiative/responsive activity, it is possible to trade with a more objective understanding of the big picture.
Monitoring attempted direction for directional performance-determining how good of a job it is doing-is the key to a complete market understanding and longer-term trading results. Once attempted direction is known, three comparative factors are useful in evaluating a market's directional performance:
1. Volume
2. Value-Area Placement
3. Value-Area Width
Volume
Volume is the best measure of a market's ability to facilitate trade. Once attempted direction is known, volume should be used as the primary means of determining directional performance.
The greater the volume of transactions, the better trade is being facilitated. In the futures market, a price movement that fails to generate a fair amount of volume as it auctions through time will likely not continue for very long in the same direction.
To determine whether or not volume is increasing, it is necessary to compare each day to previous volume figures. However, there is no standard number of day timeframe transactions in any market, for volume evolves with a market's changing activity. The key to recognizing change is to think of volume more in terms of market share than in the actual number of transactions occurring. This average will vary depending on your trading timeframe. Imagine that the market's attempted direction on a given day is up, based on a positive Rotation Factor and buying range extension. If the buying auctions are generating healthy or increased volume (relative to your determined norm), then the market is successfully facilitating trade with the buyer. Conversely, lower volume on a day attempting to move higher suggests that the market is not accepting the buying attempts.
Value-Area Placement
If attempted direction is up and volume is healthy, what impact does that have on value? Were -buyers successful in placing value higher? How successful were they? Was value unchanged, overlapping-to-higher, or completely higher? Let us briefly describe the different relationships that can exist between two trading session's value areas. First, value can form clearly higher or clearly lower, exhibiting obvious directional performance. Second, value can overlap to one side or the other, indicating a lesser degree of change. Third, when the value area is contained entirely within the previous day's value area, it is known as an "inside day." The market is in balance and is not facilitating trade with either participant. Finally, an "outside day" occurs when a day's value area overlaps the previous day's value area on both extremes, and represents greater trade facilitation. Much like a Neutral day, if an outside day closes in the middle of the range, the market is in balance. If it closes on an extreme, however, there is a "victor" in the day timeframe battle for control. A close on the highs, for example, would indicate directional performance favoring the buyer.Value-area placement often generates signals contrary to day timeframe attempted direction.
First, we must define attempted direction. Second, we evaluate trade facilitation according to volume. And finally, we must determine the relative success of that trade facilitation according to its impact on value-area placement. In general, if attempted direction is up, volume is above average (or at least average) and value is higher, then the market is successfully facilitating trade at higher prices. However, if attempted direction is up and volume is lower, then higher prices are cutting off activity-the buying auctions are resulting in poor trade facilitation. If the buying attempts also result in lower value, then the other timeframe seller is still in control of the market, despite day timeframe buyer dominance. The market must then move lower to resume balanced trade.
Listed below are 30 different relationships based on volume, valuearea placement and attempted direction. Six of them are briefly detailed in the following discussion. In addition, note that the volume comparisons in these examples are relative to the previous day, not a predefined average.
Value-Area Width
One drawback to day trading is that exact volume figures are usually not available until after the trading session is over. However, one practical way to gauge the level of volume as the day develops is through the value-area width. On days where volume is relatively low, the value area and the length of the range tend to be narrow.
The logic behind this theory is that the wider the value area, the greater the range of prices at which trade is being conducted. This results in increased participation, for as price auctions higher and lower, different timeframes are "brought in" to the market as they perceive price to be away from value. The further price travels, the better the possibility that new activity will enter the market, thus creating greater trade facilitation (and higher volume).
High Volume Areas
In the shorter time-frames, high-volume areas represent the market's most recent perception of value and, therefore, have a tendency to attract price. Naturally, all markets eventually undergo change and leave the high-volume area in search of new value. Should the market subsequently return to those price levels, the high volume region should once again attract (slow) price.
The key to taking advantage of high volume is:
1. do not try to be perfect - first execute the trade;
2. and then place your confidence in the slowing properties of volume.
If price had subsequently been accepted below the high-volume area, traders would have been alerted that market perceptions of value had changed. Long positions should have been exited immediately.
Low-Volume Areas
Low volume typically represents other timeframe directional conviction. Therefore, it is more likely to see low-volume areas occurring in unbalanced, trending markets. Low-volume prices are caused by the same forces that create excess and usually exhibit the same characteristics:
- gaps
- single TPO prints
- and tails (short and long term).
When the rejection demonstrated by a low-volume area develops, short-term strategy is to place trades using the area of price rejection for support or resistance. The low-volume area, like excess, should hold against future auction rotations. For example, single TPO prints separating a Double Distribution Selling Trend day indicate swift rejection of the initial distribution in search of a new, lower-value area. Shorts placed just below the single-print low-volume area should offer good day timeframe trade location. However, if price auctions back up through the single prints, then market sentiment has changed and shorts should be exited. When price auctions through an area of previous low volume, the other timeframe conviction that initially influenced price has changed. Traders should heed the market's warning and exit any opposing trades.
This rejection can assume one of two forms:
1. a dramatic reversal if the low volume area holds, visually represented by a tail;
2. or swift continuation back through the low-volume area, commonly represented by single TPO prints.