- 1997: Volume 6, No. 6 An Introduction to the Capital Flow Database

As the Capital Flow Database evolved over the years, the goal was not to simply find a system that worked but to understand the forces which direct market activity. This led to the need to understand the purpose of the market. This would be the foundation for a database/charting system which accurately communicates market condition. After many years of observing market activity from the perspective of both an on and off the floor trader, it has been established that the purpose of the market is the achievement of efficiency.

The market organizes itself through a process which eliminates the periodic episodes of volatility which occur. The market makes order out of disorder. All markets repetitively follow a specific cycle of action. Starting from a period of efficiency, which is characterized by horizontal price development, a dynamic vertical move will initiate. The market now begins the task of establishing a vertical range of sufficient dimension to reign in and harness the energy powering the vertical inefficiency. The force that accomplishes this is always present, always active, and always trying to gain control. This is the essence of market activity and the manifestation of the market's purpose-factoring out the inefficiencies which occur in order to establish a new efficiency. Periods of efficiency (horizontal activity) are the base from which the next vertical move develops. Inefficiency (vertical activity) emerges and eventually is eliminated leading to a new efficiency. The yardstick for measuring our progress in this repetitive cycle is relative vertical and horizontal dimensionality. As the market becomes less vertical, it is becoming more efficient. The market continuously communicates its condition in these horizontal and vertical relationships.

Freedom of Expression

Having this understanding of the market's purpose as our foundation, our database needed to satisfy one additional criteria. It must allow the market to express itself freely in both the vertical and horizontal dimensions so as not to inhibit market expression as the market cycles through its purpose. This is where the Capital Flow Database distinguishes itself from the standard bar graph. Our database structure allows free expression in the horizontal dimension. This was accomplished by indexing our database not to chronological time but to market time (efficiency to inefficiency and back to efficiency). Bar charts limit the ability of markets to communicate their condition because they are based on chronological time. The horizontal dimension is controlled by the clock or the calendar. It changes automatically. It is arbitrary to that degree. In the Capital Flow Database, the horizontal only changes when the market itself changes. Our database is composed of data segments that are generated internally by the market as it pursues its purpose of establishing efficiency by factoring out inefficiency. The following example of Capital Flow data organization will illustrate how this limitation is overcome and the market freed to express vertical and horizontal development in market time. Each 30 minute period of the day is assigned a letter of the alphabet, either upper or lower case. As a price trades during a period the letter is placed on the chart at its corresponding price. Each unit or bar contains a minimum of two 30 minute periods. The separation of a bar to form a new unit is determined by a proprietary algorithm. The September British Pound contracts which trade at the Chicago Mercantile Exchange is used to illustrate (see chart).

Figure 1

F period on the 18th exceeded the range of E period, so a new bar begins. H period trades beyond the range of G period so another new bar begins. This new bar contains four 30 minute periods. The bar did not split off to form a new unit because the trading range of J period was contained by I period. K period was similarly contained by J period. The J or K period were not inefficient (new vertical movement) so the database did not move to the right by generating a new bar. As any given day moves along the timeline from left to right it could form as few as six or eight bars or as many as 20. It is contingent upon relative vertical and horizontal activity. The start of the next bar is not determined arbitrarily by chronological time. It is dictated by market time. The Market Profile Database has freed the market to express relative relationships between internally generated market segments. As each new bar begins, a proprietary algorithm assigns a control price to the previous Market Profile bar. This is represented by the symbol to the left of each bar. Whenever an individual bar contains four or more 30 minute periods, a horizontal line is generated by the database and numbered on the display screen. It is indicative of a short term efficiency and will be discussed later. Starting with the H-K period on the 18th the market becomes very horizontal through the next five bars. We look to these tight horizontal ranges as the eventual starting point of vertical price activity. Relative inefficiency (vertical length of bars) manifests itself as the 19th begins and a genuine short-term inefficiency begins in the B-D period. It is short lived as can be demonstrated by the E-H bar, which is less vertical than the preceding bar and also contains four 30 minute periods. This generates a new horizontal line indicating another short term efficiency. The accuracy of this short term efficiency line is borne out by the fact that the next 13 bars trade at prices very close to the line.

This example illustrates the proper use of the vertical and horizontal axis in developing an objective representation of market activity. The market is freed to express its inherent dimensionality in its own time. Development, which is manifested in the horizontal, is the real market time. Development begins with the initiation of a vertical move that must be brought to efficiency. The market manifests its purpose by reigning in the inefficiency and establishing a new efficiency. This development of efficiency represents the time clock of the market. The cycle of market time is complete when a vertical move has been brought to rest. This is measured in horizontal development. This is the completion of a cycle of market activity and the base from which the next inefficiency springs.

Factoring Out Inefficiencies

Usually markets follow a four step auction process as they factor out these inefficiencies. Step one is a vertical move that establishes the high and low of the range. Step two occurs when a price is achieved that stops the vertical move. Step three takes place when the market develops horizontally around the stopping price and step four occurs as the market moves to efficiency. Capital Flow Software allows one to measure the development of this search for efficiency in market time-horizontal development. Variations of this four step process occur and themselves are highly indicative of overall market strength. The study is not affected by chronological time. It is internally generated by a market segment measured in market time.

A key element of The Capital Flow Database is its use of the computer to reconfigure the database to derive complimentary studies. An example would be a longer term reconfiguration of the automatic organizer, which measures market activity over a larger sample of time periods. Instead of each bar having a minimum of two time periods (as shown in the British Pound study above), each bar contains a minimum of sixty 30 minute time periods. When a price exceeds the vertical range of the last thirty 30 minute periods a new bar begins. A control price (based on a proprietary algorithm) is established and highlighted. Change on this page is also measured in market time. A bar can have as few as sixty 30 minute periods in a volatile, vertical market or as many as 100 in a horizontal, price control market. The benefit of using this study in conjunction with the short-term study is that it allows one to view the market from both the short-term and long-term in a horizontal and vertical display based on market time.

Database Controller

Of particular interest is a study that has been developed in the past year called the Database Controller. It contains a numeric display of relative vertical/horizontal relationships. It tracks the study described in the paragraph above and a longer term (background ) study that is a moving average of the last 40 short-term control prices (see the British Pound example). Its merit is that it is a Moving Average determined by market time not chronological time. It follows directional movement and ascends or descends as the market moves directionally. The Database Controller numerically displays increases in the horizontal and vertical dimension in both time frames as the market attempts to achieve efficiency. A two time frame study allows one to develop unique market time derived studies that can be compared to traditional divergence analysis. It measures data segments that are generated by the market as it manifests its purpose of factoring out inefficiency to arrive at a new efficiency. The Database Controller is of extreme interest because it will allow one to search a very large database of stocks and commodities in order to identify the best opportunities. As it displays both a short- and long-term index of the market's search to achieve efficiency and it can be read by the computer, it frees the trader's attention. The computer scans the database to locate whatever stocks or commodities fulfill the parameters that the trader programs. After a trade is initiated, it can be monitored by the Database Controller as it progresses toward efficiency. Studies such as the numbered horizontal lines from the British Pound example above are used to accomplish this goal. The numbered lines indicate a short-term efficiency and should be looked upon as both endings and beginnings. The market has stopped in the short-term and will either continue or reverse direction from here. Some examples of how the numbered lines can be used follow. Are the numbers continuing up or down in sequence? Here they go up 1-2-3. This implies trend continuation. Are the numbers occurring with greater frequency and at tighter price intervals? This would indicate that the market is becoming more efficient and the end of vertical development.

Several such studies exist in our database. They were all designed to track the market as it progresses in achieving its goal of eliminating inefficiency to accomplish efficiency. All studies are vertical/horizontal, based on market time, and composed of data segments generated internally by the market. The use of the computer to do analysis frees the trader and opens the door to expanded opportunity. The dramatic increase in the complexity of markets in the past 20 years requires much more sophistication on the part of a trader. Capital Flow Software is a tool that can provide a trader with the ability to compete in the markets of the 21st century.

J. Peter Steidlmayer is president and Steven B. Hawkins is director of Steidlmayer Software. If you are interested in the Capital Flow Software system or have any questions you may contact Steven on the internet at Steidlmayer.com or by phone at (312) 360-0638.