Today we are going to dive through an interesting concept which combines the Market profile and open interest and look at the buying&selling or profit booking&short covering in a more meaningful way so that we get the intention of these activities noted during the trading hours.
So As per market profile there are only two types of market activities initiative and responsive, If we convert the same into open interest terms it can be seen as follows
Initiative Buying – Comes in the form of Long Buildups above Previous Value
Initiative selling – Comes in the form of Short buildups below previous value
Responsive buying – Comes in the form of Short exits below previous value
Responsive selling – Comes in the form of long exits above previous value
But this is not what gives us a clear view on the market activity, then what does?
The prices at which these activities are happening in the overall context of the market gives us clues about the intention of these buying and selling activities.
Pretty confusing right? So here’s a simple way to get away with it in terms of simple rules from market profile concepts to identify activity as initiative or responsive.
Buying Above previous value – Initiative Activity
Selling below previous value – Initiative activity
Buying below previous value – Responsive activity
Selling above previous value – Responsive activity
Now what’s missing above is buying/selling within “value” – If it’s a buying/selling within a value it’s a judgement call based on the market context i.e, the previous trend of the market and the current position of the market in relation to it’s previous values.
While what is mentioned is a general rule and may not be the case at all times, then what’s the way out? Here it is.
There will be times when initiating activity above or below value is
not “facilitating the trade” and that is also a crucial information.
Now the question arises what is facilitating the trade? The answer is price should attract follow-up buying/selling in the direction of the initiative activity which is what is called the facilitation of the trade.
Now we take example of Friday and analyze where we saw initiative/responsive activities as seen from OIdata on OIAnalytics.in
Before moving forward we take these important Value area references from the prior day which are the base of this whole concept.
Value area high of Thursday 02/07- 10560
Value are low of Thursday 02/07 – 10460
So now we start to analyze the activity of Friday 03/07 w.r.t value of 02/07 and understand what was initiative and reponsive.
- We opened the day higher and got selling at 10579 and 10570 in the first 20 minutes of trading and as these prices at which this selling happened is above previous value these are considered to be “Responsive selling activity”
- Post which we saw some buying coming within previous value at prices just below 10560 VAH of previous value. As we know from above activity within value is a judgement call based on the context of the market, in this case it could be considered as responsive buying.
- The next notable activity came in the noon and again as responsive selling as seen below as this is at a price above previous value.
- The next notable activity came at the closing as follows
In the closing you can see both buying in the form of short covering and selling in the form of long exits,
Now here in the closing can we consider the short exits(buying) above previous value to be an initiative buying ? – The answer is YES based on the market profile concepts but what needs to be recognized here is that in terms of Open interest activity this is not a fresh buying and not to be taken as initiative activity as it’s old business.
In terms of Open interest Initiative activity is a “fresh buildup” and responsive activity is “unwinding”.
To Conclude we suggest you to go with the logic of market profile as a base and take the OI activity as a add-on confirmation in making a judgement on whether a particular buying/selling activity is initiative or responsive.
One more key note is that you can also look at the buying/selling activities w.r.t to the developing value area instead of previous value. But what matters is context of the market which is a combination of previous value and developing value.
Also worth noting here is that Initiative activities tend to create imbalances while responsive activities normally suggest balanced market.