|J. Peter Steidlmayer has been an independent trader and member of the
Chicago Board of Trade (CBOT) for more than 40 years, but he is best known
as the developer of Market Profile
and the Liquidity Data Bank (LDB), which are data displays and resources
that show price action in terms of how often (and how much) a market is
trading at a particular price level. Steidlmayer conceived these tools
from 1981 to 1983 while serving a three-year term on the CBOT's board of
After graduating from the University of California at Berkley
in 1960 with an accounting degree, Steidlmayer moved to Chicago and began
trading bonds and commodities as a pit trader at the CBOT. Monitoring
market action led to the realization that prices tended to follow a
"bell-curve"- type distribution throughout the day - most of the trading
took place at certain price levels, with progressively less activity
occurring the farther above and below the market moved from this "value
area." This discovery, combined with measuring market action in 30-minute
intervals, formed the basis of Market Profile.
The LDB is Market Profile's
complementary volume database.
Steidlmayer, 65, has written four books explaining his theories:
Markets and Market Logic (with Kevin Koy, Porcupine Press, 1986),
New Market Discoveries (with Heidy Steidlmayer, self published,
1990), 141 West Jackson (Steidlmayer Software , 1997), and
Steidlmayer on Markets, Second Edition (Wiley, 2003). Since creating
and LDB, Steidlmayer and fellow trader Steven Hawkins, who co-wrote
Steidlmayer on Markets, created Capital Flow software - a program based on
their experiences trading these methods over the past 20 years.
Steidlmayer's outlook has continued to evolve, and he has created
several new CBOT data products, such as On Floor Information (OFI) - a
ratio of average buy orders to sell orders - as well as short-term
customized spreads called X-funds (see "CME hopes X marks the spot,"
Active Trader, January 2005), which consist of a portfolio of theoretical
futures positions (long or short) picked to profit within a two-week
period. The underlying contracts aren't traded, but their movement
determines the X-fund's profitability. (The CBOT introduced X-funds in
2002 and has offered them in conjunction with the Chicago Mercantile
Exchange since October 2004.)
While Steidlmayer doesn't disavow the basic tenets of Market Profile,
he is quick to point out that popular Market Profile
trading methods used in the late 80s are no longer viable because "the
imbalance between the buyers and sellers is overwhelming the immediate
liquidity of the marketplace."
Profile of a market
Profile of a market Steidlmayer sees the market as an auction process,
which moves up and down in search of price efficiency, or the level at
which buyers and sellers are in balance. The market should move
horizontally when buyers and sellers are in balance, and vertically (up or
down) if demand exceeds supply or vice versa.
Steidlmayer realized that during horizontal moves, the price levels at
which a market traded tended to form a bell-shaped curve, in which prices
are distributed around the mode (most frequently occurring) value. A
chart organizes price data according to this principle, except it turns
the bell curve on its side 90 degrees.
charts group price into 30-minute intervals, intervals, called Time Price
Opportunities (TPOs), re p resented by different letters. For example, a
trading day (for equities) lasts six and a half hours, and each 30-minute
segment of the day is designated by one of the 13 letters from A through
Figure 1 shows a daily Market Profile
chart of Dupont (DD). The stock traded above 47 during the opening TPO
(9:30 a.m. ET to 10 a.m.) on June 15 before closing below that threshold.
It climbed the next morning, retraced some of those gains, and closed
higher. The stock slid on June 19 and 20 to close at 46.79.
The shape of a profile is what's important. The widest sections of the
profile represent areas where the market traded most frequently; most of
the day's volume also typically occurs there. The chart plots additional
rows as subsequent TPOs trade outside the prior interval's range.
Classifying daily profiles
A profile's "initial balance" (IB) refers to the first hour of trading
in any market when mainly specialists and independent traders place
trades. (The light red lines to the left of Figure 1's profiles show each
day's initial balance.)
This area was a critical reference point for Steidlmayer when he began
trading the Market Profile
display in the 80s because it allowed him to organize price action in
terms of the relationship between shorter- and longer-term traders.
Steidlmayer classified different types of daily profiles into six
groups (non-trend, normal, normal variation, trend, neutral, and running
trend neutral) based on how the market's first-hour price action compared
to the remaining periods' movement. For example, a non-trend day's trading
activity occurs almost exclusively within its initial balance, and its
range is narrow, as few longer-term traders take positions.
In contrast, a trend day features a narrow IB followed by a large
directional move (caused by longer-term traders entering the market) and a
close near its high or low. The remaining three groups identify price
action somewhere in between a flat and trending market.
Although these groups helped Steidlmayer trade Market Profile
on a daily basis, he also found these concepts made sense on longer-term
timeframes. For example, the market's range from Monday to Tuesday could
be that week's IB, while the market's price action from Wednesday to
Friday determines which of the five categories describe that week's
Four steps of market activity
The construction of profiles and their daily classifications rely on
chronological time (e.g., 30-minute, daily, or weekly increments), but
Steidlmayer urged traders to look beyond that to measure "market time,"
which means understanding how bell-shaped curves develop.
Steidlmayer's "four steps of market activity" describe patterns the
market forms as it attempts to find an efficient price. Figure 2 shows the
process for an uptrend begins with a strong up move that eventually loses
momentum as buying demand falters and sellers appear (steps 1 and 2). The
market then trades sideways around the rally's end before filling in the
lower portions of the bell curve (steps 3 and 4).
Although Figure 2 profiles an uptrend, the four steps evolve around
sell-offs in a similar way. Traders who follow traditional profile
analysis try to determine when a market has built a bell-shaped curve and
then look for a directional move out of the "mode line" - the price level
with the most horizontal movement.
This process seems fairly straightforward, but it doesn't adhere to
chronological time, which makes it difficult to spot on daily profiles.
Instead, traders must combine TPOs from several days to find out what
stage the market is in. And most charting platforms that offer Market
can't combine TPOs from diff e rent days. (Aspen Graphics, CQG, and
Steidlmayer's Capital Flow software let you consolidate multiday
For more information about Market Profile,
visit the CBOT's Web site (www.cbot.com). Also, see "Trading order flow
with Market Profile"
(Active Trader, May 2005) for a detailed explanation of the four steps of
Liquidity Data Bank
While Market Profile
is primarily a price display, the Liquidity Data Bank is only available on
CBOT contracts and contains important volume information, including the
number of cleared trades for each 30-minute TPO and a percentage breakdown
for the four types of traders - locals or specialists, commercial clearing
members, members trading for other members, and general public (see Figure
These categories, known as Customer Trade Indicator (CTI) codes, can be
used to find out how different traders reacted to market conditions. For
example, commercial traders, or hedgers (not speculators) tend to "fade"
an intraday trend and take the opposite position at the day's extreme,
according to Steidlmayer. The "commercials" may not be right, he says, but
the LDB allows you to trade with them, or any other trader type, if you
The LDB, provided by the CBOT on an intraday or daily basis, also
includes each contract's so-called "value area," at which 70 percent of
The evolving nature of markets
In the 60s Steidlmayer noticed that markets tended to form bell-shaped
curves each day as they found an efficient price by the closing bell. He
profited from selling daily highs and buying daily lows in anticipation of
an intraday trend reversal.
However, this "responsive" behavior shifted in the late 60s as
commodity funds formed and their managers began buying high and
(hopefully) selling higher in anticipation of a continuing trend.
Steidlmayer altered his trading style to adapt to the changing
environment, a shift that taught him to focus on the present tense as
opposed to using historical patterns to predict the future.
Steidlmayer says today markets don't actively form profiles each day
because "imbalances," or directional moves, are now so overwhelming the
market can't integrate them and form an efficient price by day's end as it
did 40 years ago.
"The market's basically changed to where we have selling followed by
buying," he says. According to Steidlmayer, the market used to move
sideways to integrate the imbalances (as it formed a bell-shaped curve),
but it now moves down and back up in two separate phases. This means the
basic tenets of Market Profile
such as the five daily classifications and the four steps of market
activity don't work as well as they did in the past.
Many of Steidlmayer's new insights are based on volume analysis, which
is an internal, or market-generated measurement as opposed to an external
one, such as a moving average.
Analyzing volume is essential for electronic traders because it's the
only internal information they have. In contrast, pit traders had many
cues such as activity and mood to gain insights regarding market
Steidlmayer's On Floor Information (OFI) calculation is one compelling
example of his new discoveries since developing Market Profile
and LDB more than 20 years ago. OFI is a ratio of each day's average buy
order to its average sell order:
(Bought contracts / buy orders) / (Sold contracts / sell orders)
Steidlmayer has suggested going long if the OFI is above 1 and early
buying occurs the next day; he recommended shorting the market in response
to the opposite conditions (OFI below 1 followed by early selling).
In Figure 4 for example, the numbers above or below each daily profile
in the December corn contract show OFI values. Green profiles represent
days in which the average sell order is larger than its buy-order
counterpart (OFI < 1); blue profiles show the opposite scenario (OFI >1).
Overall, corn tended to sell off when the OFI is less than 1 (April 27 to
May 3) and rally as it crosses and remains above this threshold (May 13 to
Figure 5 shows Barrick Gold Corp. in Steidlmayer's "block volume"
format, which divides volume into several groups. For example, if a
contract trades an average of 50,000 contracts per day, Steidlmayer labels
each day's volume based on this level (i.e., 35,000 and up equals heavy
volume, 20,000 to 24,999 is medium, and 12,000 to 19,999 is light). Here,
volume is measured in half-day intervals and the morning's volume is
compared to the afternoon's trading.
"From April 22 to 25, volume is usually heavy in the first half and
lighter in the second half (red and blue TPOs, respectively)," Steidlmayer
says. "The market has that pattern so there's no real imbalance. On April
26, though, ABX has a heavy-to-heavy (morning vs. afternoon) volume
imbalance that can't be taken out because the price drop represents the
weighted end of the volume spectrum. If you had sold on April 26, you
would have made money because our study identified this imbalance."
The same imbalanced volume pattern appeared the next day, but ABX
leveled off before retracing day, but ABX leveled off before retracing
this sell-off in the following five days. At this point, normal
heavy-to-light activity precedes another heavy-to-heavy imbalance, yet ABX
According to Steidlmayer, if ABX trades below May 10's low of 22.75 and
volume becomes heavy, the stock should stay below that level without too
much risk because afternoon volume can't take out the earlier heavy volume
- therefore, May 11's price drop isn't surprising.
future as a database
Steidlmayer explained these concepts when we visited him in his CBOT
offices in late May. We also spoke with him about the hurdles facing
individual traders and the importance of proprietary databases, among
AT: How can traders profit from Market Profile
and Liquidity Data Bank these days?
JPS: They need to get their own database, measure time, and find
imbalances in the market. If you don't find imbalances, you have nothing.
Trading's biggest cost is time, which is also its biggest lever. This
trade (Figure 5) took time out of the market.
Take the Long-Term Capital Management's (the high-profile hedge fund
that collapsed in 1998) model of trying to find historic trades and
borrowing money. That's very risky.
Instead, expand your database so you don't have to rely on leverage.
You'll get $10,000 in annual interest if you're making 10 percent, but
what if I give it to you in a shorter time period? Saving time pays a
higher rate of return vs. leverage, which decreases as time goes on.
If your strategies don't measure time - which Market Profile
does - you don't have much of a chance.
AT: So Market Profile
filters out the randomness?
JPS: Right. We're measuring time, so the market's on the clock, so to
AT: Similar to the way point-and-figure charts shift toward market
time as opposed to chronological time?
JPS: Yes. When I started trading, point-and-figure charts were my
introduction to Market Profile.
It's an outgrowth of (that methodology). Point-and-figure charts can move
a trader forward in terms of understanding the market - not necessarily in
terms of making trading decisions. Instead of making mechanical decisions
based on pure technical analysis, if you use point and figure, you've
gained a better understanding of the market. This wakes up your brain a
little bit vs. other chart styles.
AT: How do you compare Market Profile
to traditional price based technical analysis?
JPS: Market Profile
does not use chronological time. And if time is your biggest cost, you'd
better have a "market time." Everyone else uses chronological time and
price-to-price relationships. Price has very little or no value as a data
JPS: Because there's a buyer and seller at each price. Time only
defines price in the past tense. Assume a new contract began trading at
10. There's nothing you can say about it. But you'll have some reference
if it traded at 4 last month.
Take a look at the trading industry. It's not using the database as an
asset, and it's toiling instead of working. Technical analysis uses price
against price, and price itself is not a data point. Moving averages don't
exist in the real world.
has survived even though the market's changed dramatically in terms of how
it's used. It differs from technical analysis because you are now closer
to being a part of the market rather than just making observations.
There's a big difference there.
AT: What's wrong with back testing trading ideas against historical
price data? Doesn't that have some value?
JPS: Well, the markets have changed a lot so you're comparing apples to
oranges. First, you don't have a constant. If you're not testing the
market, what are you really testing?
AT: The probability of whether a trade idea might be profitable.
JPS: No, you're testing how your tolerance works. Back-tests miss all
the ingredients that may have been good.
AT: Such as?
JPS: When you look to the past for references, you're going to be late
(making trading decisions) because you don't know a high or low has
occurred until it's in the past. So you're looking for one scenario and
the market's doing something else. Market Profile,
however, shows development that you won't see in a back-test; they only
show how good your external parameters are and these (variables) dominate
AT: What would you say to traders who are using Market Profile
as a visual display on different charting platforms and are studying your
JPS: It's a pass-through cost (i.e., it won't be very helpful), not an
asset. I'm building a database with Market Profile
. Everyone should have their own database and understand the nature of the
markets they're trading, which allows them to create opportunities instead
of finding them - a big step.
In the future, 75 percent of bond volume will be a part of something
else. If there are 200,000 bonds traded per day, there will be 800,000
contracts trading the yield curve, among other possibilities.
AT: Do you mean trading different spreads with the bonds?
JPS: Right. And spreads measure time, don't they? So as 75 percent of
bond volume will be related to other products, why doesn't the CBOT relate
soybeans to other products too? Why don't we combine gold with other
The Board of Trade could take $7 trillion sitting in passive stock
funds, and the game would be over - it'll be ours. Our industry is already
in the time-cost business, so we should take time out of the equation.
The X-funds have already proven this works. The two Xfunds we
introduced at the CBOT in 2002 were products created from various
contracts. Each fund had a 10-day time horizon.
They gained $23,000 within six months. One small-margin ($1,500) grain
fund made around $7,500, and another commodity fund ($3,500 margin)
returned about $17,000. The products also had no drawdown.
I told the CBOT it would be successful because they're investment
products that take time out of the market. We made 104 trades with a
winning percentage of 51 percent, yet the funds climbed 69 percent.
Although we had one winner for every three losers, the winner was bigger.
X-funds are just the beginning of what exchanges can do. It was a
viable product, but it wasn't successful because it required a change in
nomenclature. There wasn't enough volume in 2002, but we're reintroducing
them because (they per - formed so well).
AT: So now the CBOT and CME together are bringing back X-funds?
JPS: Yes. X-funds were created opportunities since their overall
winning percentage (69 percent) exceeded the individual trades'
(percentage of gains).
There are a lot of products that could help the CBOT become the leading
financial institution in the world without too much effort. It's in our
grasp now - the only question is whether our leadership will take these
We have to service a new industry that will grow about 10 times by
2010. People who are buying memberships to the CBOT at these high prices
aren't joining to trade soybeans.
AT: Will customized spreads - not only yield curve bets that
traders have placed for years - but spreads involving commodities and even
stocks, really become viable products?
JPS: Yes. It's going to happen. I've put stocks together and a lot of
these do very well.
In the future at the CBOT, someone will be able to buy IBM, 10 bonds,
and 20 soybeans (futures) along with it.
And what happens to the zero sum when a third party's involved? Both
principle parties win.
AT: How does that work?
JPS: The changing open interest takes care of the zero sum. Assume, for
instance, you and I are in a contract (that consists of multiple
positions). We share the gain, and the third party carries the loss.
Third-party transactions really open up the field. That's what's happening
in the yield curve. It's not one vs. one.
Say we have four products put together like an X-fund. Here, the four
contracts' changing open interest flushes the zero sum elsewhere.
AT: Because they're related to other things?
JPS: Yes. (The zero sum isn't just related to one product.) Imagine buying
a coupon bond and taking the coupon off. Structured products divide these
instruments and trade both parts. We'll do the same thing.