In the world of technical analysis, granular data is equivalent to gold. The characteristics of a good technical indicator are that it can represent a lot of data with ease of readability.
This is the reason why candlesticks are among the most popular technical indicators for both intraday and long-term trading. Candlesticks represent the high, low, open, and close prices over a time unit in a single readable pictorial representation.
As seen above, a trade can gauge the range in which the stock or currency pair has traded in a given amount of time, the direction of the move, and the final closing price all in one simple block of the monochromatic picture.
In fact, candlestick use is so prevalent that candlestick patterns such as Doji, inverted hammer, shooting star, hanging man, and many others are common parlances in the world of trading, and a number of systematic trading strategies are based solely on these patterns.
Drawback of candlesticks
But like all technical indicators, candlesticks, too, are not perfect. The first observation would be the absence of one critical piece of information regarding the price move – lack of volume data.
Traders who are on the lookout for breakout trades very well know the importance of using volume data in conjunction with the price. While price represents the direction of a stock’s move, the volume of stock traded during that move indicates how strong that move is.
Any trader can tell that they will be more confident in a stock sustaining its upward or downward momentum if a large volume accompanies the stock price move.
Despite all their simplicity and efficacy, Candlesticks do not represent volume data over time, which can become a major handicap for traders. Proponents of candlesticks might say that one can easily observe the tick by tick data, as seen below in conjunction with the candlestick chart, and determine the strength of a price move.
However, there are two flaws in this setup. First, as discussed above, is the lack of compact representation. A trader will constantly have to match the candlestick with its volume tick which is not very convenient.
Second, the volume bar tells us only about the volume during the entire duration of the candlestick and doesn’t show what the volume was and each of the levels in the price range represented by the candlestick.
Footprint: a novel yet simple modification to candlesticks
To overcome these drawbacks, traders clubbed the price data with volume data and modified the candlestick chart to create the footprint chart.
A footprint chart is a tool, just like a candlestick chart, and not a strategy in itself. It is created by adding volume data or order flow data to the existing candle chart.
The footprint is quickly gaining popularity in the trading community, and service providers have recognized the same as several of them have started providing the functionality to create footprint charts.
Footprint charts offer an additional dimension in their diagram to the traders, letting them absorb more information in the same bandwidth. Traders can further customize these charts to include the specific variable they want to include: bid-ask or volume or any other liquidity or flow indicator. The time frame is also customizable depending on the trader’s strategy.
The above-demonstrated example is that of a bid-ask footprint. As can be seen from the image, the footprint includes price information, as can be seen in a standard candlestick but further provides information on the number of bids and ask orders on each of the price levels.
Thus a trader can get a sense of the number of orders at each price level and at what level were the sellers dominated by the buyers.
Types of footprint charts
Now as you must have sensed from the previous example that the above template is convenient to demonstrate an additional axis of data apart from price.
Now that data can be anything ranging from the volume which we discussed initially to the bid x ask orders, as seen in this example of a number of other parameters that might aid a trader in gauging the market sentiment based on her or his trading strategy. This gives a number of variations in the footprints chart, which we further discuss below.
Volume Footprint: while a volume histogram only offers data on the tick level, a volume footprint would offer volume data on each price segment. This chart allows traders to understand at which price point was the highest and activity and which price levels could easily capitulate due to a lack of volumes on those levels.
Bid/Ask Footprint: This variation offers an easily digestible snapshot of market participants looking to tweak their bids and asks. With this variation, traders can identify which side is able to influence the price more, the bulls or the bears.
Delta Footprint: Delta footprint shows the difference between volume from the buyers and volume from the sellers so we can observe the net volume at each price segment. So instead of looking at both buy and sell volumes, traders can quickly identify which side is more aggressive at a particular price level.
Profile Footprint: Unlike the previous types of footprints that numerically represent the data, profile footprint stacks the data up in a bar chart with the size of the bar at each price showing the quantum of the data.
For example, the profile footprint in the above example represents the delta value from the adjacent chart and you’ll notice that the higher the absolute delta value larger is the bar size.
Footprint charts: a formidable tool in the right hands
If a trader uses footprint instead of the traditional candlesticks, they will be better positioned to understand the market microstructure and sentiment and leverage its informational edge to make outsized returns in the markets.
But one must understand that it’s a tool and not a strategy in itself at the end of the day; hence, a trader must be clear on how to use it. A market maker, for example, can use it to exploit scalping opportunities. In contrast, a momentum trader can use it to identify and confirm price range breakouts or the strength of the momentum. Overall, the footprint is a precious tool in the hands of a skilled trader.