Trading for Value, Part Four

Today, in part four of the Trading for Value series, we’re going to break it down and lay it out.

We’re going to spread some of the most important pieces out on the workbench and see how they all fit together. It’s going to be a bit technical. Maybe even a little dry by comparison to some of the other installments. But that’s because a lot of information is going to be packed in here. So grab some coffee (or an adult beverage depending on the time of day, of course) and read on.

What’s the “it” being broken down? Well, it’s this concept of the value candle. We’re going to walk through:

  • what they are/are not
  • some of the important visual patterns
  • how those patterns compare to things that might be more familiar

And then lastly we’ll examine several charts in several markets to show the kinds of instruments on which this kind of analysis yields the most and clearest insights. I’ll say right up front that this is not a Swiss Army Knife of an analysis tool. It does not work well on every instrument and trading situation. In fact, it’s pretty specialized and intended to be used on very short time frames. And as great as it is shaping up to be at aiding the trade in certain instruments, it’s only just ho-hum on others.

First, Some Context

Let’s do a little “level setting.” No, this is not a trading pun. It’s a bit of jargon we used to use before a big meeting at a certain monstrously huge software company where I worked. It means we need a little context before we get to the heart of the matter. An informational appetizer, if you will. The most important contextual assumption below is one that is so ingrained in my thinking I often forget to mention it. And that piece of context is that most all patterns are only worth your attention at prices or levels you have previously identified as important.

At other times (or prices), patterns of most all kinds should be considered noise. It’s only at or near real inflection points that action of any trading kind should be taken. And one of the most interesting things about real inflection points is that they are pretty predictable. The exact wrong approach in most any trading method is to act on a trigger or signal at just any old price. Some prices are way, way, way more important than others, and for the purposes of this discussion please pretend that the examples shown are in fact important prices. We could literally be here all week if I went through the entire process of price/level triage, and you’d never make it through to the end. I might not either.

For the sake of expediency I’m just going to pull some charts up from under the counter, ala Ron Popeil, so you can see the finished product.  Besides, level-finding and price triage will be the subject of a future series of posts. ;-}

Pogo Sticks

I am a very visual person and an aficionado of metaphors. So while these things are called value candles, almost every time I see them I think of a pogo stick. Why? Well, in a way, value candles look and function much like an actual pogo stick. Here is an enlarged value candle taken from an actual chart. Now tell me the resemblance is not striking:

Acme-Value-Candle---Pogo-Stick

 

There are really 3 fundamental components to the value candle/pogo stick:

  1. The handle/spine, which is actually the bar range. In this particular case, it’s an OHLC bar. It’s the central support, if you will, for the whole thing.
  2. The spring cylinder. In a real pogo stick, this houses the spring that gives the toy its rebounding energy. So it is with our value candle. It’s the 1-sigma value area of the bar and it’s where the bulk of the bar’s energy is stored.
  3. The foot pegs. In a real pogo stick, the pegs are attached to the internal spring. When compressed by human weight against something solid, they cause the rider to rebound into the air. In this metaphor, the pegs are actually the bar VPOC, or volume point-of-control. The point of control is simply the price at which the most volume is traded for that bar/profile/period, etc.

As we’ll see in a moment, the value candle VPOC very often displays the same rebounding characteristics. The more deeply it is compressed into the value area, the more likely price is to bounce the other direction very shortly thereafter.

Now one very interesting characteristic of this particular pogo stick is that it works both directions. Right side up or upside-down, the spring can be sprung.

Potato, Po-tah-toh

Before we go much further, I want to point out that the value candle concept is not something that we at Acme made up. In fact, it’s something we pared down. You see, the value candle is simply a volume profile, visually streamlined and reduced to its svelte, naked essence.

Let’s have a look to compare. Here is the same 5 minute bar of the same instrument from the same day and time, but “clothed” two different ways: on the right, in a single-bar volume profile; and on the left in a value candle.

Acme Value Candle vs Volume Profile

So you can see same essential/critical/most important information is displayed in both the value candle and the volume profile – the range, the value area and the VPOC. Though by comparison, the value candle is much less visually noisy.

And as we’re about to see, that increased focus on the essential information can render a rotation-in-the-making easier to spot.

On the Rebound

So what are the kinds of pogo patterns we’re looking for? Again, generally speaking, we’re looking for the body of the candle (actually the value area, or the range of most-accepted prices within 1 standard deviation of the VPOC) to be positioned toward the outer extreme of the bar range, and also for the VPOC to be positioned toward the outer range of the value area. The further toward the outer extreme the better. Remember, in this metaphor, the outer extreme is the top of the range if price is in an upward rotation, and the bottom of the range if price is in a downward rotation.

For the examples below, we’re going to use 3 minute candles. The choice of 3 minutes is pretty arbitrary to be honest. It’s just that for fast-moving instruments 5 minute candles may be too long. And for slower-moving instruments 1 minute is too short. So this is the happy medium I’ve chosen just so we can have a kind of apples-to-apples comparison.

Beyond that, each of the charts has 3 studies on it:

  • The Acme Volume Profile VPOC, which actually makes the value candles on the chart
  • 2 instances of the Acme Volume Profile Value Channel, with one value area set at 68.2% (1SD), and it’s the inner gray-shaded channel. The other is set at 95.5% (2SD), and it’s the blue upper and lower channel lines. These are on the chart simply for reference to the session’s value area context. See here for more on standard deviations, if you’re not sure what those really mean. Yes, pun intended that time. ;-}
  • One instance of the simple Acme Volume indicator. This shows relative per-bar volume at the bottom of the chart instead of in a new panel.

One last thing before we get to the annotated charts. I’ve cherry-picked some pretty clear examples. Better to start with an ideal and learn to recognize valid but less ideal examples than the other way ’round, methinks.

From Under the Counter

First up… West Texas Intermediate Crude (CL). This is a prime candidate for this kind of analysis as it has clean, volatile short term swings and is often driven by aggressive price discovery. This means key levels are frequently faded, and that’s exactly the behavior that value candles were conceived to reveal. In this example we have clear pogo stick patterns on a swing high and a swing low:

Acme Value Candles - CL2.14.2012

Next up… gold (GC). Here again we have a swing high and a swing low, though not on in the same session. Pretty similar patterns. A bit trickier to read by comparison, though.

[one_half first]

Acme Value Candles - GC High2.13.2012

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[one_half]

Acme Value Candles - GC Low2.16.2012

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Of all the indexes, by far the one that makes the cleanest pogo patterns is the Russell Small Cap Index (TF). Why? While I can’t be 100% sure, it seems to be the least arbitraged of the index futures. Again I need to highlight that this is speculation, and it has fairly light volume at around 125K contracts per day. So no matter what, it’s much, much easier to move around than, say, the ES (which we’ll see next).

Acme Value Candles - TF High Low2.15.2012

And with that, I’ve saved the worst for last. I think for an instrument like the ES, this really is not the best tool. There is so much volume in the ES with so many players acting on so many time frames with so many purposes all at the same time that it really can’t form clear pogo patterns on most rotations.

Value usually takes so much longer to play out in the ES than with many other instruments. Again, mostly this is because the ES is commonly used as both a position vehicle and a hedging vehicle. Meaning that institutions buy a basket of stocks and sell ES contracts against that basket to hedge the position, for example. Still other traders take outright positions on the S&P 500 with the ES contract. Both could be happening at the exact same time, and thus can tend to “confuse” the price action in the very short term.

These differences of volume and simultaneous intent in the participants cause each of these instruments to have a very different character. How so? Let’s look at a couple value candle examples in the ES:

Acme Value Candles - ES2.14.12

Conclusion

My hope is that this walk-through delivered some clarity on the value candle concept, why it works, what it’s useful for seeing and when it’s not so good too. Again, this is a new concept we’re developing, and so far it’s showing lots of promise. It’s in successful, daily use by a number of Acme traders, a couple of whom you’ve already met, and there are definitely more examples to come.

Have a great long weekend, amigos. Trade ’em well…

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[iconbox  title=”For Rancho Dinero Members” icon=”emblem-important.png”]The template used to make the charts shown above as been added to the Acme Chart Template Library.[/iconbox]
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7 replies
  1. Sandy
    Sandy says:

    Exceptional, this was value indeed (no pun)….I am going to attempt to superimpose VPOC bars with wave analysis…..I can see valuable potential insight into this…

    Reply
  2. PMAT
    PMAT says:

    Thanks Troy for sharing. Very interesting indeed.

    It would be the icing on the cake to have the pogo stick width proportional to the volume traded (and then we could get rid of the volume bars). ALL the crucial information would be displayed at once !

    My two cents,

    Pascal

    Reply
  3. PMAT
    PMAT says:

    Hi there,

    could someone explain me why the value channels are not symmetrical aroung the VPOC ? And sometimes, the upper or lower border of both channels would meet.

    I would expect something more a bollinger-band style kind of thing.

    I hope my question is clear 🙂 !

    Many thanks in advance for your help,

    Pascal

    Reply
      • PMAT
        PMAT says:

        Hi ED,

        thanks for your answer. I read your essentials just after posting my question. And it’s now very clear to me !
        Many thanks again for your help !

        Pascal

  4. James Kelly
    James Kelly says:

    better late than never… this is very cool ! thanks so much for being so innovative. I want to get rich trading CL, this will no doubt help me on
    my way 😉 Your products are of excellent quality, thank you !

    Reply

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