Bitcoin Market Profile

Brent Donnelly is a senior risk-taker and FX market maker at HSBC New York and has been trading foreign exchange since 1995. He is the author of The Art of Currency Trading (Wiley, 2019) and his latest book, Alpha Trader, hits the shelves in Q2 2021. Brent writes a daily email focused on FX markets that is my go-to source for understanding that enormous corner of the market, but in truth his writing is applicable to every aspect of investing.

You can contact Brent at  [email protected]  and on Twitter at @donnelly_brent.

As with all of our guest contributors, Brent’s post may not represent the views of Epsilon Theory or Second Foundation Partners, and should not be construed as advice to purchase or sell any security.

Funny how bitcoin topped on the exact day of the COIN IPO and dogecoin topped out on 4/20. Life is so rich. Now we get to see if every 2021DisruptorCo. CFO is already all-in on the “treasury cash balances into the coin!” idea or if there is more ammunition to buy the dip as levered retail cuts losses and faces margin calls just before they need to sell even more crypto to pay for tax bills coming due May 17. Should be an interesting few weeks for crypto and equities.

When an asset goes up 500% in 5 months, you can use your imagination when estimating drawdown possibilities but as discussed a few days ago^[1], here are some possible buy-the-dip levels:

On the flip side, if you are long and looking for places to get out, I can help with that, too. One of my favorite charting methods is called Market Profile. It is a bit like point-and-figure charting, but also different. It synthesizes market data and cuts out noise. The two best resources if you are interested in learning about Market Profile are: This 350-page pdf from the CME, and the book Mind Over Markets (Dalton and Jones). I have also included my full explanation of Market Profile from “The Art of Currency Trading” as an appendix to today’s piece.

Anyway, the idea is that Market Profile identifies equilibrium zones in an asset by identifying and clarifying the relationship between price and time (see example in the box at right). The more a price trades over time, the larger the stack of letters will be against that price. For example, if you are using 60-minute windows and bitcoin trades $49,500 to $50,000 for 6 hours, those price points will each have 6 letters next to them. This slowly forms a series of equilibrium distributions that looks like the one in the sample box.

When I look at a market profile chart, I am mostly looking for two things: 1) the equilibrium zones and 2) the single prints. Single prints are prices that traded only one time period. They represent places on the chart where the price was not comfortable and could not find equilibrium. Gaps and price points that were quickly rejected show up as single prints. Single prints become important pivots going forward.

Now let’s have a look at the Market Profile of bitcoin since the Coinbase IPO:

Takeaways:

• There are three clear equilibrium zones, all $5000 wide. The top of the current zone is $52,000 so that is the first resistance. More patient or more bullish sellers can wait for $57,000, the top of the second equilibrium zone.
• There is a series of single prints around $57,000/$59,000. This means that very little or no volume went through in that area and thus that becomes a massive pivot. Longs from the week of the COIN IPO are trapped at levels above that single print zone and will be happy to bail as it gets close. This further emphasizes the $57,000 level as huge resistance. Expect massive selling between $56,000 and $57,000.
• Support is $42,000/$45,000 (the bottom of next equilibrium zone + 30% drawdown level). If $42,000 breaks, $26,000 is a possible crash support.

Personally, I’m bearish bitcoin until we see a serious post-COIN IPO cleansing. If you are patiently waiting to sell, the ideal place to layer some sell orders is just ahead of $52,000 or just ahead of $57,000. If we ever get a daily close back above $59,000, the entire post-COIN IPO dirtnap has been rejected and the bull trend will be back in force.

Appendix: Market Profile in The Art of Currency Trading (Wiley, 2019)

There are many ways to process the torrent of financial data that rushes through the global pipes every day. Bar and candlestick charts are the most popular presentation format for financial time and price movements but there are other equally valid ways of slicing and dicing the data. One alternative method of charting that I find useful is called Market Profile (also known as Market Picture). In this section, I will introduce the basics of Market Profile, discuss how I use it in my trading, and provide some options for further reading.

Most of the charts on my trading cockpit are in candlestick format. Market Profile is my second favorite way of looking at time and price data. There is a decent body of literature on Market Profile so consider this section a ‘quick and dirty’ on how I use Market Profile and if you find the topic interesting, check out the suggestions for further reading at the end.

The main benefit of Market Profile is that it gives you a quick and highly visual way of looking at several days’ worth of intraday price action. Here is the Market Profile for EURUSD from July 3 to July 10, 2013.

You can access Market Profile in Bloomberg by typing EUR {CURNCY} MKTP {GO} on Bloomberg. There is a similar option called “Volume at Price” in Reuters Eikon and you can find Market Profile in most professional charting systems. If you don’t have access to Market Profile on your system, it is easy and useful to create the charts yourself.

Some people like to create the Market Profile manually as the day progresses using graph paper and a pencil. It is a really good idea. Manual intraday charting gives you a great feel for how the day is developing and gives you a more visceral connection to the price action. You will probably find it gives you a stronger feel for your market. It also gives you a good idea of how the Market Profile is built from the ground up. When I have the time, I build Market Profile charts manually throughout the day. I find doing so helps keep me in the zone.

Each letter on the chart represents a block of time throughout the day (60-minute blocks are used in the example above). So if there are many letters in a row beside a price, it means that price traded many times throughout the day. Each column of letters represents a day and the date is indicated on the x-axis below each column. Look at the column of letters above July 10^th, for example, and you can see that 1.2770 (the small letter u) only traded during one 60-minute period, whereas 1.2820 (where you see “GIKMOQS”) traded in 7 separate hours of the day. The more letters there are, the more the price traded during the day.

To build the chart manually, simply create a blank grid on graph paper with 10 pip intervals on the y-axis. Then put an A beside every price that trades in the first hour of trading, put a B next to every price that trades in the second hour of trading and so on. I suggest you try this for a few days and see how it feels. If your time horizon is shorter, you can use 30-minute or even 10-minute intervals. This can help with focus and concentration. When people read a suggestion like this in a book, nine times out of ten they just keep reading and forget about it. Don’t do that here. Build your own Market Profile charts during the day! It is a fantastic exercise that will make you a better trader.

Market Profile gives you the ability to quickly identify equilibrium zones. These are the areas where many letters form large clusters. The longer a row of letters, the more times a given price traded that day. To repeat, areas with many letters show equilibrium zones where a lot of trading took place.

At levels where there are very few letters on the other hand, the market traded only briefly before more aggressive sellers or buyers came in and quickly pushed the price away. This is all you really need to know to start using Market Picture. The key is to focus on the equilibrium and non-equilibrium zones.

The simplest trading strategy I use with Market Profile looks for what is called a SINGLE PRINT. A single print is a point on the market profile where there is only one letter because the price traded there but then moved away before the start of the next time period. When you see a single print, you can clearly see that the market rejected this price point aggressively and therefore this is a price point that you should consider a key pivot.

Let’s look at that same Market Profile chart again. On July 4^th (07/04, as indicated on the x-axis) there is a series of single prints (all denoted by the letter Q) as EURUSD fell from 1.2990 to 1.2940. This happened after a very dovish ECB statement^[1]. The most important thing to know is that price gapped through this level and therefore anyone who wanted to sell in the 1.2940/1.2990 window was unable to do so because the price did not remain there for long.

This means that rallies back towards that zone will likely be sold as players that missed selling on the way down will try to sell when price gets back up there. I would never trade a Market Profile single print (or any technical formation) by itself. Instead, I note the level as an important pivot and use it to maximize leverage and/or determine my stop loss when I come up with a view and take a position in this currency pair.

Let’s say now it’s July 5th and I am bearish EURUSD because I think yesterday’s dovish ECB statement will meaningfully change expectations for the currency going forward. We are trading at 1.2840 and I believe risk/reward in selling here is poor because we are too oversold. So I don’t want to get short here; I want to sell a rally.

The ideal trade is to wait for the price to get back towards the bottom of the gap down zone from July 4^th. You can see from the chart that today’s high was around 1.2900/20. I would use other charting techniques like moving averages to further zoom in on the optimal entry level but with the information we have here it looks like 1.2900/40 is definitely the sell zone. This is an example of technical convergence as major resistance (today’s high 1.2900/20) and the edge of a single print zone (1.2940) are nearly the same. So we want to get short ahead of those two levels. Ideally other indicators also highlight the importance of the 1.2900/40 area and we are closer to a Five-Star trade.

With the information we have here, the optimal trade is to sell EUR just ahead of 1.2900 with a stop loss above the single prints. So in this case we leave a limit order to sell at 1.2898 and a stop loss at 1.2990. This is highly preferable to selling at 1.2840 because it allows us to take a bigger position with much better expected value. You can see the next day the high was 1.2900/10 so we went short and the price soon fell back to 1.2770 over the next day or two.

As mentioned earlier, trading is a game of inches. If you left your sell order at 1.2920 in this example, you missed the move back down.

There are many, many other interesting ways of looking at Market Profile charts. My main objective here was a) to make you aware of the existence of Market Profile and b) to inform you of how I use single prints as key pivots in my trading. As with everything in this book, I encourage you to internalize what you find useful and discard what you don’t. You need to develop your own style and your own methods. I’m just here to open some doors. Explore Market Picture and come up with your own ways to use it in your analysis.

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