In continuation of our series of updates to the ‘Market Profile classroom’, we look at the importance of the Market Open today.
The open is a very critical aspect of the market Profile as it emphasizes the continuation or lack of continuation from the activity at the end of the previous trading day, even more so in the markets of the NSE which do not have a 24 hour trading system.
The open price will tell you of a shift in the assessment of the market action from the point of view of the Buyer or the Seller.
Let’s look at the following chart :
The chart is a price profile chart of the Nifty Future from the 20th of May till yesterday.
Notice the points marked A, B and C.
Point A in the chart has an open much below the close and there is seen a continuation of the trend, so sellers were successful in keeping the larger trend from the previous day which was a down day.
Point B also has a preceding down day, but notice at the open the trend has changed.
Point C on the chart has a preceding up day and the trend continues up the next day.
The Important question to be asked is- looking at the open, how do we know that the trend is changing or remaining the same.
The answer lies in the activity right after the open, that is the reaction of buyers or sellers to the auction process or the new prices. As we have discussed already, the initial balance sets the tone for the day action where buyers and sellers try to establish the balance for the day.
Let’s look deeper into the activity at/ after the open.
Normally a typical day in Market Profile is characterized by the value area and the day range which are the day extremes ie the high and the low.
Accordingly we can have two types of open depending on the price action of the previous day :
1) Open outside of the previous day range.
In this case the sentiment and the balance of the market has changed a lot and there can be large activity in either direction as buyers and sellers grapple with the new information that has just entered the market.Normally these kind of days are seen after a major news announcement in the overnight markets or on weekends.There is significant movement and risk-reward in such days as the open causes the equilibrium of the market to change
2) Open inside the previous day range
This kind of open has one subset.This would be characterized by an open in the value of the previous day or outside the value of the previous day.
a) Open within value : Here the market open is telling the trader that the market is in balance and buyers and sellers are agreeing on value. Prices usually in such cases move within value offering low risk-low reward opportunities, till the balance changes.
b) Open outside value : This represents a medium risk-medium reward opportunity for the trader as their is a dispute or contention over value in the market. Hence right after the market open you would find traders moving to or away from value creating good trading opportunities.
The open also creates the probability of the infamous 80 % rule or the value area rule to come into play.This rule has an 80 % chance of working as a favorable trade, that is 8 successful trades in every 10, hence one should look out aggressively for this opportunity.
The 80% Rule:
The 80% rule is easy to understand. It simply means, if the market opens above (or below) the value area and then gets in and stays in the value area for two consecutive half hour bars, it then has an 80% chance of filling the value area. With that in mind, a good strategy is to try and ride the market as it fills the value area. There are two scenarios to watch for:
a)If the market opens above the value area and then gets in the value area for two consecutive brackets, there is an 80% chance of the market filling the value area.
b)If the market opens below the value area and then gets in the value area for two consecutive brackets, there is an 80% chance of the market filling the value area.
A copy of this post is in the Forum under Market profile Classroom.