STEIDLMAYER ON MARKETS

 

STEIDLMAYER ON MARKETS

PETER STEILDMAYER

1. Peter Steidlmayer (Chicago, IL) joined the Chicago Board of Trade in 1963 and has been an independent trader ever since. Steidlmayer served on the Board of Directors of the Board of Trade in 1981-1983.

• When I worked for my father, I learned not to run away from a problem and to finish what I started. Our philosophy was to do the job once and do it right.
• Do not compete outside yourself; try to be the best you can within your own abilities. But learn from observing yourself and the many types of people around you.
• Learned that by watching you could perceive a sense of order. Emotions and impatience do not produce results, observations and understanding do.
• In my family, your job was you. A reflection of your standards.
• I realized that if I stayed within the accepted standards for the job, I would not learn anything. By stretching myself beyond the standards, forcing myself to do mor, I learned a lot.
• I learned that if you pay more than fair value for something, time is against you; but if you underpay, time is on. Your side. This became the underpinning of my approach to trading commodities.
• The main thing is to be consistently good over a long period of time. Play the compound interest game. Build your base slowly and surely. A small increase on a big base is better than a big move on no base.
• The key in business is to make sure that you win in the long run and that you can sustain yourself on the downside.
• If you can handle the downs. You’ll always be successful -that was my father’s theory. This same principle has worked as part of my trading strategy.
• I started trading but I was unsuccessful. I inherited $500 from my grandfather, who died at the age of 99, and I lost it all in 1 day.
• I still remember the page of the textbook where it said that through the bell curve, out of apparent chaos comes a beautiful cosmic order.
• During the summer of 1959, I took a finance course that introduced me to the principles of value investing through the classic work of Graham and Dodd. Their book, Security Analysis.
• I came up with the idea that the bell curve could be used to represent an ar- rangement of behavior around price. The first standard devia- tion—the middle of the bell curve, where the majority of activity takes place (68%) would represent value, whereas the second and third standard deviations would measure price away from value. Whenever the market moved away from value, I would take the opposite side of the trade.
• I would sell the zone indicated by the number 1 or buy the zone indicated by the number 2 because I felt that the market would return to value (the center of the bell curve).
• An example of initiating selling (selling below value). In a responsive market, participants act just the opposite. As a market moves higher or lower (away from the previous day’s value), sellers or buyers enter the market feeling that the market will not continue moving directionally. They feel it is just a mat- ter of time before the market trades back to what is considered an area of established value. They respond to a directional move up by selling into a directional move down by buying it.
• As a trader, I was basically playing for this symmetrical pat- tern to develop using the number of minimum trends at each price level as a timing device. I would play for the high-volume price to be at or close to the middle of the day’s price range. A trader could fade or go against a higher or lower opening in any market, and this strategy would work about 95 percent of the time—again reflecting the responsive nature of the markets. My simple strategies worked well at the time—much better than the same strategies would work today. To illustrate my trading tech- nique in the 1960s, assume we had a half-completed distribution at the end of a trading day. The minimum trend profile might look like Figure 2–9. The Xs represent the prices traded for the day. The following day, the market opened two ticks lower at 97 (assum- ing the previous day’s close was 99). Under these conditions, I would be a buyer of the market knowing that the market was un- balanced and must come to balance in a responsive situation. I would be counting the number of minimum trends at each price (reflected by the number of Xs arranged horizontally at each price) and playing the fill-in, knowing that when the bell curve was completely filled in, I would be out of time at each price. Thus, I was using time rather than price as the key factor in my trading. Figure 2–10 shows the second day’s activity, following that of Fig- ure 2–9. The Os represent the minimum trends on Day 2.

• The faster the market moved away from a price, the more it indicated that the price was an excess or a noncompetitive area of the mar- ket.
• Observations like these give a set of circumstances that can be dealt with logically as traders. By following my experiences and observations during my early years in Chicago, the reader is probably beginning to see that it is possible to read the market in the present tense, not just after the fact. Learning to do this is a definite advantage for a trader.
• I had a friend on the floor who had amassed a small fortune only to lose it in 6 months because he never modified his program. One of the keys to being a successful trader over a period of time is to adapt to change. You must be able to find a new program when the old one is not work- ing, and have the discipline to implement it.
• My strategy had become mainly one of follow through. The new strategy was to be an initiative-type trader. Instead of sell- ing when the market left the first standard deviation (the value area) on the upside, as a responsive trader would do, I would ini- tiate a trade going with the direction of the market away from the first standard deviation. I would look to see if the move gen- erated increased volume. If it did not show increasing volume, I would begin to get out of the position. The significance of vol- ume refers back to a lesson mentioned earlier. If higher prices did not bring in additional volume then the higher prices were not facilitating trade (creating interest) and the higher price would be moved away from. Just like when the pit was full, it would mean that the market was apt to continue moving directionally be- cause the price activity was generating interest. Conversely, when the pit emptied, it indicated alack of interest (volume) that would likely lead to a reversal of direction or rejection.
• Market Profile is different from previously existing charting techniques. It is the result of an effort to meld the concept of value investing as expressed by Graham and Dodd, the bell curve from statistics, and the work of John Schultz’s minimum trend.
• The difference between ordinary technical analysis and Market Profile is that MarketProfile uses the evolving market rather than past market history as its database.
  • Second, Market Profile is more of a present-tense, internal in- formation source as opposed to other technical tools like moving averages and relative strength, which are external to the market. Market Profile attempts to replicate what a trader standing in the pit sees that allows market activity to be read as it develops.
  • A third difference between traditional technical analysis and Market Profile is that traditional technical analysis tries to pre- dict the future based on the past. Market Profile tries to identify the underlying conditions of the current markets movement for continuation or change. These underlying conditions are ex- pressed as the Market Profile expands horizontally, vertically, or in both directions
• In most cases, the Market Profile resembles a normal distri- bution curve, which, as statisticians have found, is the most com- mon organizing principle in nature. Because market behavior is human behavior, it is logical to expect that prices would follow the same statistical patterns that govern other human groups.
• 4 STEPS
  
  
  
• Step 1, which is a series of prices in one direction (often called a distribution), could be the function of an economic num- ber and therefore have a life of only a few minutes or it could be a far more significant event that lasts a number of days or longer. The second step in this cycle is the stopping phase. This does not necessarily mean the market cannot trade higher or lower than the stopping level, it means only the expansion phase has run its course and momentum should be waning. The third step is the development phase, which signals some degree of acceptance around the stopping price. In some time frame, it would be de- fined as the first standard deviation. Finally, step 4 is an attempt for the market to move to efficiency, in other words retrace some of step 1 and move the first standard deviation back toward the middle of the vertical range of the structure. A structure with a completed step 4 would look like a normalized bell curve. How- ever, the markets do not make things easy and at times the mar- ket can skip step 4 and continue in the same direction as step 1. At other times, the steps are shortened or skipped all together. Once again I want to emphasize how important it is conceptu- ally to understand this four-step process and be able to visualize the process in day-to-day trading. The reader who can accom- plish this task will move far along the curve of becoming a suc- cessful trader,guaranteed!
• Understanding and distinguishing between these two types of activity are difficult for many traders. In this section, I give some tips that should help the reader deal with them conceptually and practically.
  • First, consider initiating and responsive activity as they re- late to the previous day. Use the previous day’s value area as a reference point. The value area is defined as the first standard de- viation of that day’s range. In other words, the value area should encompass approximately 68 percent of the day’s volume or TPOs.
  • Next, reference the market activity of extremes, range ex- tensions, and TPOs as they evolve in the newly developing day. The key is to track market activity above or below the previous day’s value area. When today’s activity is buying below the pre- vious day’s value area, this is responsive activity. So is selling above the previous day’s value area. Participants are responding to “cheap” or “expensive” prices relative to previous day’s ac- tivity. They are buying belowvalue and selling above value.
  • By contrast, buying above the previous day’s value area or selling below the previous day’s value area is initiating activity. The reason for generating initiating trades is because partici- pants perceive a shift in value. They are going with the flow.
• The concepts of initiating and responsive activity can also be related to developments within the day. Simply refer to the first, second, and third standard deviations for the developing day. The market is described as initiating when it is in the second or thirdstandard deviation; it is responsive in the first. This is il- lustrated in Chapter 9.
• The Steidlmayer theory of markets is that the mar- ket is a organized medium that expresses human behaviors in different price areas at a given point in time, always presenting an opportunity to someone. Though this statement appears sim- ple, itcontains a lot of meaning
• A Steidlmayer distribution would encompass the first three of the four steps of market activity. Those steps are a series of prices in one direction, trading to a price to stop the market, and finally trading around that stopping price. The distribution, the stopping, and the development around the stopping price are the essence of the Steidlmayer dis- tribution.

• What creates this type of visual is easily explained using the four steps of market activity. What creates the vertical range for the profile is step 1 (the distribution), a series of prices in one direction (down in this case). This strong push to the downside reaches a climax where there is little interest in continuing to sell lower prices; thus, the price probes lower and finally stop. The stop- ping of the distribution is step 2. Following the stopping phase, the market will probe both higher and lower, using the stopping price as a sort of anchor for development, or step 3. This devel- opment zone or step 3 in the four steps of market activity will constitute the first standard deviation of the Steidlmayer distri- bution. Once step 3 is established, the market will attempt to move to step 4, which is the trade to efficiency (attempt to cre- ate a normal bell curve, 3:1:3), where the price activity attempts to move the first standard deviation back toward the middle of the vertical price range. How this occurred is shown in Figure 9–4, again March coffee fast-forwarded to include many more weeks of price activity. Once the market has stopped pushing in a direction (see Fig. 9–3), it attempted to retrace the selloff of 50 cents to 45 cents. The market managed to retrace that 5-cent selloff and then some; it eventually makes a new high versus what had been the high in Figure 9–3.

• A trader has one job—to be an objective observer of the market. This means she or he should observe the story being told by the market as it develops vertically and horizontally. When a good risk versus reward opportunity presents itself, a tradermust take it. Then she or he continues to objectively monitor market de- velopments.
• Market discipline has many connotations. Practically speak- ing, it is the school of hard knocks. It means the market will punish those who try to fight it. It is a discipline that the market can and does impose on its participants. You learn by doing, by asking questions of yourself (e.g., why did I sell into a rally?; why are all my trades responsive?), by not repeating your mistakes, by taking responsibility for your actions, and by not complaining about what ifs, what went wrong, and so on. You are in a con-tinual learning mode.

Market understanding  You  Results

• Having a losing trade does not necessarily equate to an error on the part of the trader. The game is complex and the number of variables involved in trading preclude anything approaching per- fection. Your job is to do whatever you can to improve your skills. It will improve your odds and your results. But if you never take the time to learn why you do what you do when you are trading, you have no chance of improving yourself—you are cutting your potential in half. Remember, the you is half the equation. If you apply yourself and learn to comprehend the propensities you have as a trader that are limiting your results, the trading experience can be a much more satisfying one. If you are half the equation, maybe you should get half the analysis.

The game plan or blueprint I have built over time is:

• Work from background to foreground.
• Incorporate the visualization process to ascertain where you are within the four steps of market activity.
• Apply the internal time clock of the market to help supple- ment this information.
• Utilize day structure (range parameters, single prints, idiosyn- crasies of markets) to optimize entry mechanism.
• Objectively mange positions (both winning and losing) with structure, not price.
• Control risk.
• Use stops.
• Vary size.
• There is a saying “You pay the grocery bills with the day-to-day trading and put the money in the bank with the long-term trading.” Similarly, most very successful traders will probably tell you they accumulated the majority of their wealth on a very small percentage of their trades.
• This is not to say that early entry or OFI should be used only for scalping purposes. A friend who was the biggest trader on the London International Financial Futures Exchange (LIFFE) floor used this trade setup for years with great success. A pattern he noticed was that on the first day of the week the German bund would have an open and drive–type setup. He would watch the open to determine direction and initiate a position with a stop a few ticks through the opening price. If the trade was working for him, he would hold it to the open of the U.S. market and possi- bly to the close of the European markets. Prior to this year (2002), this strategy worked over 70 percent of the time for him.
• I mean the range extension above the first hour’s range is approximately the same number of ticks as the range extension below the first hour’s range. The neutral day in Figure 6–8 displays this symmetrical characteris- tic. The first hour’s range during y and z periods was expanded by 5 ticks to the upside and 5 ticks to the downside. Thus, the buyers’ and sellers’ commitment, or more specifically lack of commitment, is about equal. Buyers and sellers committing to an idea and not getting a payoff are the reasons for the phe- nomenon of closing near the middle of the day’s range. This indecisiveness of the buyers and sellers also creates the self- fulfilling prophecy of neutral days begetting neutral days. There is no strong conviction by the longer-term participant, therefore they get involved, see no follow through, and get out. The oppo- site biased participant does the same thing, causing a preponder- ance of neutral days.
• If, within the day, you see more than 2 half-hour up rotations, assume the market has lost the strong selling momentum, and thus get out of your short position. If you are involved with this type of trade, always exit by the close of a trend day because there is some 90 percent chance the market will trade sideways or reverse that day’s priceactivity the next day
• The type of day structure I trade most aggressively because it gives very specific entry, exit, and stop levels is the neutral day. As opposed to the trend day, which features one-dimensionality and day time frame participants overwhelming the market, the neutral day features the opposite extreme—longer time frame participants are active and the market is random or developing. Trading for neutral structure can be anticipatory or totally ob- jective, depending on how aggressive you wish to be. For in- stance, all markets have certain idiosyncrasies that can be learned over time through observation. I have noticed that if a market is going to unfold into a neutral day, the expansion above or below the day’s first hour of activity typically will not exceed “x” number of ticks.
• The answer to this question lies with the user. The macro trader or specialist on the floor would have different definitions of background and foreground. In summary, trading single prints offers a great opportunity because it puts you on the outer edge of recognizing minus development. The shal- lower the retracement into single prints, the greater the probabil- ity of a larger vertical move away from this area. Risk should be managed to the other side of the single prints because taking away all the single prints would signal a market in equilibrium or price control, which is not what we aretrading for.
• Do not use arbitrary “monetary stops” when exiting a trade. In other words, do not buy a stock at $40/share and arbi- trarily place a sell stop at $36 with the intent of risking a 10 percent move in the underlying. Instead, you should study the trade setup and choose an exit price dictated by market activ- ity. For example, reading market activity may indicate the lo- cation of the exit price should be at $37.50 or possibly $32.00. You may be comfortable with a stop at $37.50, but you may wave off the trade with a stop at $32.00 because you cannot justify risking a 20 percent move in the stock. Simply stated, plan your trade before you execute. And trade your plan after you
• There is a saying, “don’t turn a mistake into a problem”; in other words, do not attempt to manage bad trades into breakeven or winners, just get out and start fresh. You will expend all your energy and go through all kinds of mental gymnastics trying to break even.
• The last word: I would like to leave you with a quote from Calvin Coolidge (1872–1933).

Press on: nothing in the world can take the place of per- severance. Talent will not; nothing is more common than unsuccessful men with talent. Genius will not; un- rewarded genius is almost a proverb. Education will not; the world is full of educated derelicts. Persistence and determination alone are omnipotent.