ASX Charting Course
Chapter 60
Capital Flow
There was a fundamental shift in commodity markets during the 1980’s and 1990’s. Not only were there many more products, such as financial futures, but these markets were inherently 24 hour markets. Hedge funds and other large trading entities materialised with generous concentrations of capital. This, coupled with accelerated flow via electronic means promoted a structural change in global markets.
The emergence of this new capital phenomenon, which probably started around the same time the US broke from the gold standard, changed the way money entered and exited the market. The world governments no longer backed currencies with hard reserves like gold and silver. New money was created using debt instruments. It was borrowed into existence. It’s no surprise that the bond futures markets, become the highest volume markets traded in the world during the 1990’s. Stock index futures, also became increasingly popular as they allowed access to other various global stock markets, not just individual domestic markets.
We therefore needed a way to analyse the new Capital Flow, a new way to organise and look at the data. The market profile principles were still applicable, but the unit being used, the day structure, was no longer as relevant.
Capital flow is price distribution. Quite simply, if the market is rallying, capital is said to be flowing into the market and if the market is falling, capital is more than likely flowing out of the market. If the market is going sideways then capital flow is balanced, capital is not flowing.
Capital Flow as a charting technique is an extension of market profile. In essence it is a way of organising half hour data into continuous distribution curves, not constrained by time. It yields a distribution curve with a definite beginning, an obvious development phase and often, but not always, a clear conclusion.
Organising the Data
As with the Market Profile, the data is organised into building blocks of a half hour time frame. Each half hour is assigned a letter and these letters are plotted against the Y-axis to reveal a distribution curve. If we ignore the individual trading sessions and start plotting the curve when the market is making a vertical move, higher or lower, a distribution will emerge once the market starts to go sideways. It’s this aspect of the market that we can measure now, the degree of horizontal-ness, as well as the degree of vertical-ness.
Vertical movement is measured in price, that hasn’t changed, but now we can measure horizontal movement in terms of time-price opportunities (tpo’s). A tpo is one letter, one price print in one half hour period.
Fig 111
The chart above shows a normal half hour bar chart on the left and each half hour range has been assigned a letter of the alphabet. This is compiled into a distribution curve on the right, revealing a point of control at 4193.
The point of control is the mode of the distribution, the price with the highest number of tpo’s. It is the most traded price in the distribution and represents best value.
Value = Price x Time
Skewed Distributions
A normal distribution curve has three basic standard deviations
Fig 112
The distribution curves formed in the market tend to be either balanced or skewed in one direction. In fact, most distributions begin with a skew, a bias, in the direction of the recent vertical trend in price.
As the horizontal activity becomes more prominent, the skew tends to disappear, the distribution becomes balanced. It takes on more of a normal shape except for one thing. In the case of an aging, balanced, distribution there seems to be a definite lack of a second standard deviation.
Fig 113
The first standard deviation is comprised of the bulk of the scores around the mode or in this case about 60-70% of the tpo’s around the point of control. This is commonly referred to as a value area.
The second standard deviation seems to be only present when the distribution is skewed and disappears if the distribution becomes more balanced, as in the diagram above (fig 113).
The third standard deviation is found at the extremes, the tails.
Fig 114
In the above diagram the distribution has been from higher prices to lower prices and is called a 321 down distribution. The market still carries a bias to lower prices, but the extreme vertical section of the down move has been shut off with horizontal development. A new value area is developing as a result of this horizontal development.
Fig 115
A 321 up distribution has a large buying tail, the third standard on the low side and the first standard deviation is at the high side. Price has moved from high to low and been shut off with sideways, horizontal activity.
Craig MacLean is a Futures Adviser Licensed under the Australian Securities Commission, Corporations Law. The writer accepts no responsibility for any losses incurred from any action or inaction derived from the advice in this report.