Analyzing market volume

Now let’s think like a professional trader for a moment. If you think a market
is stalling out and you might want to lighten your long position, you are not
going to rob yourself of a tick and bail out at the market. Rather, you’ll
expect that the market will trade at the bid, then the offer, then the bid,
rotating back and forth as it stalls out. You’ll work an order in the book,
offering some of your inventory for sale to see if residual buyers will do your
work for you.

On the other hand, if you’re in a rush to get out of the market and think we’re
going lower, you’re not going to play games and work an order to get an extra
tick. “Don’t be a dick for a tick” is what you’ll tell yourself and you’ll take
what the market gives you, unloading some of your holdings at the bid.

That’s pretty much how a market maker thinks. Now there’s another class of
trading professional that is less concerned with the moment to moment flow of
prices around the bid and ask. This is a longer-timeframe participant who trades
with an opinion. A hedge fund trader, for example, might have research that
tells him or her that the odds of the market breaking its low for the day over
the coming three sessions are quite high. That trader will use the rally–and
the market’s enhanced liquidity during the rise–to get into a short position
and ride the anticipated move. Given the expectations of a 10+ point move in ES,
the longer timeframe trader isn’t going to get cute and work orders for an extra
tick. If the bids are there in the book to be had, they’ll hit them and get the
position established.

When we see 5000+ contracts trading at a level over multiple price levels, we
know that this is above average volume for this time of day. The odds are great
that both of these groups of professional market participants are active. The
skewing of volume from the green to the red–from the willingness to take offers
to the need to sell shares–tells us clearly that their sentiment has taken a
sharp U turn. That’s the brick wall I referred to in my post.

When you see a brick wall, you note the price level and say “Sayonara”. There is
just too much supply relative to demand to sustain that price level. Conversely,
in later market action, if we *do* take out that price level, what better market
indicator could you have that the demand/supply equation has changed?

Now let’s go to a different portion of the chart. Along the left side, you’ll
see a volume histogram and numbers along the chart’s Y axis. What that’s telling
us is the volume that has printed at that price cumulatively through the day.
When the numbers are green, we can see that the majority of the volume at that
price during that day was at the market’s offering price. Red indicates that the
volume was at the bid. The histogram is broken down into green and red so that
we can see, not only total volume relative to neighboring prices, but also the
distribution relative to bid and offer.

Notice what happens to the histogram as we move from 1309 to the market’s high
price. We’re seeing less cumulative volume at higher prices. What that tells us
is that the market has not facilitated trade north of 1309. High volume at any
price level tells you that, over time, the marketplace is accepting that price
as value. What we have with the brick wall pattern is a rejection of value at a
given price range. The “tail” left by a Market Profile (not displayed here) is
also a tell-tale: a sign that supply overwhelmed demand on that occasion.

We also, if you notice, rejected value at the lower end of the market’s range.
That was a brick wall in a different direction: supply overwhelmed by demand.
The observant trader will note those price levels well to see which side of the
range will facilitate trade in the coming session. That will provide the
demand/supply shift cues that alert you to a market breakout.