MODULE 10 - AUCTION MARKET THEORY AND MARKET PROFILE
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- Auction Market Theory
- Market Profile
- Market Profile + Footprint
- Volume Profile
- Videos and Links on Market Profile and Auction Theory
Even though Market Profile charts were developed about three decades ago, there is still a great deal of misconception and confusion about them. Many traders still do not understand what Market Profile Charts can and cannot do. Unfortunately, this prevents many traders from being able to truly learn and harness the power of the profile.
The profile offers many advantages that are not available on any other type of chart. The original intent of the Market Profile was to provide traders with real time access to trading volume data. Now, remote traders can share the same type of valuable information that floor traders had access to by being in the pit. The profile development was welcomed by professional traders and continued to be the tool of choice for many of them.
In 1982 Peter Steidlmayer, a Chicago Board of Trade Member and Mike Boyle, the Vice President of Technology at the Exchange developed a vertical graphic that captured and demonstrated the market dynamics of price and volume over the course of the trading day. Price and volume data are presented in a logical and visual manner. This original vertical graphic is now described as the market profile chart. This new way of looking at market data allows traders to organize and make sense of real time information.
Market Profile + Footprint
The first key advantage of the profile chart is that, it provides traders with the best real time view of market activity. The profile chart when combined with a footprint chart gives us an x-ray vision into the market. A trader can actually see exactly what is happening in the market as it happens. Once you are able to understand what is happening in the present, you are able to make far better decisions about what might happen in the future.
The profile graphic simply involves a vertical price scale that provides a range of prices for a trading period. That price scale starts with lower prices at the bottom and increase to higher prices at the top. Typically, a specific letter on the chart represents thirty-minute period of trading. Whenever the market trades at a certain price, a letter is printed on the graphic at the designated price level. As each thirty-minute period is completed, a profile of letters is developed for the trading day.
Using this simple pattern of letters, the Market Profile chart provides traders with a coherent view of how the market is developing. Fair price levels that are accepted are easily identified as more and more letters accumulate in front of them. While prices that are rejected are seen at the extremes of the chart with single letters in front of them. Using the principles of normal distribution, the price data is graphed to provide us with a bell shaped curve. This curve identifies the value area in the market.
In addition to a profile chart, we are also able to use the footprint charts. Footprints offer a multidimensional view of market activity. They allow us to see the exact volume that is traded at the bid and the exact volume that is traded at the ask. We can actually see this in real-time as it happens for every single price at any point in time. See Fig 1.
Traditional charts are one-dimensional whereas the footprint charts give us a multi-dimensional view. Every price or data point in each footprint cell contains actual price and volume data. In addition, each cell has a dynamic color to signify the intensity of buying or selling activity at that price. It is possible for us to look at every single price and immediately identify the level of interest and the actual traded volume at that price. Thus providing us with an accurate and clear real-time view of actual market activity.
The second major advantage of market profile charts is the fact that in order to use it a trader must first learn to understand how the market works. This is a great benefit, it actually forces a trader to learn and understand the key market concepts that lead to successful trading. Some traders that use a signal system are often trading in the dark. They never really understand how the market works and are at the mercy of a signal. Many others rely on indicators or trade setups, again without understanding market behavior. Unfortunately, without a coherent understanding of the market, it is very difficult for any trader to be consistently successful.
The Market Profile, on the other hand, is an analytical tool. It requires the trader to understand and analyze the market. Trading decisions are therefore based on judgment. Judgment based decisions requires a trader to carefully analyze the market before placing a trade. A proper analysis cannot be done without an understanding of the profile elements and the profile is based on an understanding of the market.
Trading based on an understanding of the market is a completely different experience from trading based on a signal or an indicator. The informed trader is able to trade with a completely different degree of comfort and confidence. Their trading decisions are based on an actual hypothesis about the market. They are able to adjust and mange their trades quickly and efficiently. For a trader to genuinely harness the power of the profile they must understand the market dynamics. In my personal opinion, this is one of the greatest benefits of using market profile charts. It actually forces traders to learn and understand the market before they trade. This fact alone can often save many traders a great deal of time and money. Moreover, it allows for far better trading outcomes.
Value is an essential concept for both buyers and sellers of any item or service in any market. The same holds true for buyers and sellers in the financial markets. All professional traders base their trading decisions on their perceptions of value in the market. Consequently, it is important for traders to be able to identify and detect where value is in the market. The market profile provides us with the best gauge and view of value in the market. Imagine as a trader, being able to know where true value is in the market at any given point of time during the day.
As trading activity occurs in the market, the profile graphic evolves and shows us where value is in the market. There is no other charting tool available that will display market value like a profile chart will. Many day traders often trade without any clue as to where value is in the market.
The market value area is especially important for day traders to identify. It guides short-term traders to the price levels where the greatest volume of trading is taking place. These are the price levels where the most two sided trading is taking place. These price levels will have the greatest liquidity during the day. The liquidity makes it possible for a short-term trader to easily enter and exit their trading positions quickly during the day. The profile chart defines the “value area” as the price range where approximately 70% of total trading volume occurred in a given time period. Shown in Fig 2.
Market Profile identifies where value is in the market:
Many indicators and signal systems are designed to only work under specific market conditions. Some will work in trending markets, while others will only perform well in a sideways market. The market profile, on the other hand, provides us with an accurate picture of market behavior in all types of market conditions. It works equally well in a trending market just as it does in a sideways market.
It actually, helps in identifying the type of market conditions that exist. There are distinct profile patterns for trending or directional markets as well as bracketed or consolidating markets. The profile patterns actually make it easy for a trader to identify the type of market and market sentiment.
Sideways or range bound markets are characterized by a narrow price value range and a wide profile structure within that value area as seen in Fig.3.
However, a wide and expanding value area and a narrow or vertical profile shape characterize directional markets as seen in Fig 4.
The market profile provides some great advantages for swing traders; it can show them where the market is balanced or imbalanced, helping them in detecting potential directional moves. In addition, analyzing a sequence of day profiles or creating a single composite profile for a specific number of days can yield a treasure trove of valuable information for both day traders as well as swing traders.
When the market is moving directionally, it is immediately visible on the profile charts. As the value areas begin to move in the direction of the trend. As we can clearly see in Fig 5., the value area identified by the green lines continues to move down on consecutive days. Whereas when the market was uncertain about direction we can see that, the value areas remained within the same price bracket as observed in Fig 6.
These advantages make the profile an invaluable part of any serious trader’s arsenal. However, in order for a trader to effectively use Market Profile Charts, a trader must invest some time and energy in learning and understanding this powerful analytical tool. The rewards are certainly well worth the effort. As a trader becomes more and more proficient in applying profile concepts, they will wonder how in the world they could have ever traded without it.
Market Auction Theory Useful Links:
Market Profile - Useful Videos:
September 12, 2019