The MarketDelta Blog

This question, and others similar to it, are frequently part of my email inbox. It might be two traders with different value areas, or a trading student that doesn’t understand why his or her lines don’t match the instructor. The practical answer, in every case (excepting instances of data issues which really are quite rare) relates to chart setup.

Here is a portion of an email I received today:

“I’m new to your software though I am not new to trading… Your software is very powerful and my numbers were different from those given by a supposed expert, so I guess I was curious if I was setting this up correctly. … My assumption is that there is a “standard” way to set this …”

Now, I appreciated this individual’s courtesy, sometimes emails aren’t quite as polite. In fact, sometimes users are convinced something is wrong with the software, without realizing just how many variations exist on calculating the so-called Value Area. And the potential for frustration is not limited to Value Area calculations. Any calculated quantity can be come “suspect”. Here is the reply I provided to this user and my hope is that many of our blog readers might find it insightful also.

REPLY:

The basic concept, when Peter Steidlmayer first presented the trading community with this fantastic notion, is that of basic statistics: the bell curve and standard deviations off the mode (what you and I call the POC). Way back then, there was no volume data, just TPO’s. And the calculation of the value area was done by hand, a sort of short hand algorithm. This calculation is described in the book Mind Over Markets.

Fast forward twenty to thirty years. We all have a ridiculous amount of computing power. We have tick by tick trade data including volume. And, we have a bunch of smart (and some not so smart) peopel figuring out new ways to see, calculate and use this data.

For instance, a value area can be based on TPO’s or it can be based on volume. But the calculation used to “count” the TPO’s or volume may be a computerized version of the original by-hand method or it may be the strict mathematical definition (which is not the same). Now, lets further complicate the issue by pointing out that the “POC” is most often the mode, but the mode of what? The high TPO count or the high volume node. Or, do you want to be really strict and use the original definition that requires the “highest TPO count closest to the middle of the range”. Think about what that can do on certain days. Then, we have some folks who said, more or less, forget about all this old fashioned stuff and go strictly stat’s all the way through: no POC. Let’s calculate the VWAP (volume weighted average price) and put standard deviation bands around the VWAP.

I hope your head hurts now, because mine does. At least it does if I think about it too much. I get lost trying to recall exactly what part of our software does what at what times. The good news is that almost always there is only a small variation between the various calculations and when the difference is big, the reason is usually obvious. For example, a day where the high TPO count price level is far away from the high volume count price level. In this case, you’ll have to make a judgment call.

So, if your levels are off by a point or more (sometimes several points) you can see that something as simple as how the POC is calculated can have dramatic effect. So, which levels do you trade? The answer is ridiculously simple and painfully simple: use the levels that work. For me, this boils down to using the computed levels to compare against actual chart support and resistance. If you have a level, and nothing on the chart supports this calculated level, I won’t trust it. If, on the other hand, I have NO calculated level, but the chart tells me support or resistance is present, I’ll believe the chart. Ideally, you want the calculated level to match what the actual chart bars are saying.

The calculated levels are based on a certain logic, but in the end, those levels are there to help you focus on where to be looking on the chart, and then letting the chart prove that the level is valid. Sorry for letting this get so long, but it took this many words to really answer your question.

—- A final note: the above assumes no database issues exist and you have adequate data to do the calculations. For detailed information about the various Value Area set up styles please see the blog post on Everything Value Area