The MarketDelta Blog

Over the next few weeks, we are going to demonstrate how you can chart, signal, and backtest a simple but popular trading strategy based on the “Initial Balance” levels made famous by Market Profile charts. Today we look at the concept itself. Check back with this blog regularly to see the additional installments in this series.

Concept

All trading systems must begin with a concept, or expectation of market behavior. Without a solid idea for a trading methodology, you can’t easily build trading signals and create backtests to determine historical profitability.

Except for trending days, when price tends to move consistently in one solid direction for the course of the entire day, the market usually “rotates” on most days by reversing at price extremes. Traders who accurately predict where these reversals occur can be quite successful. One way to estimate where rotational extremes may appear is by looking at levels created by the Initial Balance.

Market Profile traders are familiar with Initial Balance (IB) levels on their charts. The IB is most commonly defined as the range of prices during the first hour of trading. From this range we get additional price levels that could hold as reversal points on any given day. Some common price extremes are the Double IB High and Low. These are simply the full range of the IB extended above and below the High and Low of the IB to get the 200% IB High and 200% IB Low.

For example, if the Low of the first hour was 1200, and the High was 1210, the IB is a 10-point range. Add this range size to the IB High and IB Low and you get 1220 for the 200% High, and 1190 for the 200% IB Low. (150% IB extensions would be halfway between the IB and the 200% IB levels.)

By default, the Market Profile charts in MarketDelta automatically chart these levels:

Notice how the market came close the 200% IB Low and then reversed, or “rotated,” back up towards the center of the distribution. This is part of the idea behind Market Profile methodology. You may hear traders talk about “reversion to the mean” or a “return to value.” This is often the mechanism behind reversals at price extremes, such as the Double IB High or Low.

Look at these examples as well:

Though you could create signals and backtests for both 150% and 200% IB levels, or any other level you choose, we will start with the 200% in our tutorials.

The goal of this blog series is to ask the questions: How often can we reasonably assume that a 200% IB extension will hold? How many points away from this IB level is optimal for taking a trade entry? How profitable would I have been if I only traded 200% IB reversals for the last several months? What’s the best stop to have for this trading strategy? How long should I hold a trade to maximize my profit potential?

All these questions can be answered within MarketDelta using the Professional Complete version of the software, which allows you to build custom RTL algorithms to enhance your trading.

Stay tuned for our next installment, in which we build a custom RTL indicator to see these levels on a multi-pane chart, such as a bar or candlestick chart. This is the first step in generating an accurate RTL system for this concept. We hope that through these tutorials you will see how relatively straightforward RTL programming can be.