Market Profile:

The Market Profile (MP) was developed in the early 1980’s by The Chicago Board of Trade and Peter Steidlmayer as analytical decision support tool to organize and display market generated information.

The Market Profile’s key components are time, price and volume which are then combined and displayed in a statistical distribution much like a normal bell-shaped curve to reveal pricing patterns and value.  The trader makes trading decisions based on an independent evaluation of market price and value information.

The Market Profile Trader, through study and experience, can learn to identify the market’s underlying dynamics and structure (trending vs. trading range) and then initiate, manage and exit trades accordingly.  This differs from typical technical analysis which usually measures price movement.

•    A structure for organizing a developing market.
•    A horizontal and vertical display of the dynamic process of market activity.
•    A visual display of the market’s current ‘value’ or ‘fair’ price range.
•    A decision support tool to help traders better understands the ‘present’ condition of the market.
•    A tool for recording the market’s activity through the organization of time, price and volume.
•    A graphic reflection of all market participant opinions.

MP is a way of reorganizing price data in order to provide more information and deeper understanding of support and resistance.  Support and resistance represent supply and demand in the market.
Lower prices attract buyers and support level below price is where we anticipate demand to enter the market.

Higher prices or resistance points above the current price is where we anticipate supply and sellers to enter the market.

Market profile theory suggested that the market is constantly shifting or rotating between these points of supply and demand, known as the Value Area.  The Value Area is a bracket that represents an area in which 70% of trades took place.

The point of control (POC) is the price level at which the greatest number of trades took place.

Market Profile Day Types:

Normal day: Occurs when 80-100% of the day’s price range consists of the initial balance. The initial balance, delineated by the single vertical line appearing to the left of the graphic, is the price range established during the first two 1/2-hour periods of the trading session.

Normal Variation: On such a day, the initial balance comprises less than 80% of the day’s price range, and range extension — either up or down — can more than double the initial balance. As the market probes toward the top of the initial balance, it is advertising for selling. Such a price move would be expected to produce sufficient selling to result in consolidation; instead, on the day in question, buying resulted in E-period buying range extension above the initial balance. Similarly, selling can result in selling range extension below the initial balance.

Trend Day: When a trend day occurs, the market is moving through time, and must be monitored closely. Such a day is characterized by an unusually narrow initial balance. Additionally, the market moves consistently in one direction, but not sufficiently far at any one time to elicit a consolidation-promoting reaction that would result in a value area; the result is a long, narrow profile, generally moving in one direction. It is not unusual for a trend day to close within a few ticks of its high or low.

Trend days are one-time-frame markets. The trend day depicted below is a one-time-frame up market, in which all participants are buying, and in which buying promotes additional buying. Each 30-minute bar generally has a higher high and a higher low than the previous one: that is, the market is not rotating.

Double Distribution Trend Day: A variation on the trend day is the double distribution trend day. This day starts off much like a trend day, however there begins to be rotation with a bell curve beginning to develop during much of the day. It appears that more of a normal variation day will result. But then new information enters the market and range extension occurs and drives prices to a new area. At some point the move is shut off, usually overshooting, and then another bell curve begins to develop. The resulting profile will have two areas of price rotation, which are usually separated by an area of single prints. These days can often occur on Fed days, or days where a surprise announce or event occurs. The market goes from balance, to imbalance as the news drive the market to a new level, and then back to some sort of balance as the news is digested.

Neutral Day: A neutral day is characterized by range extension — both up and down — with little follow-through. Range extension occurred, and resulted in no net influence.

Neutral days are relatively balanced and symmetric, and it is not unusual for such a day to close near the center of the day’s price range.

p- Shaped Profile Day: A profile shaped like the letter P; thin volume at the bottom and heavier volume at the top. This is typically due to a Short Covering Rally. This   typically occurs as a result of Shorts covering rally.

b- Shaped Profile Day: A profile shaped like the letter b; thin volume at the top and heavier volume at the bottom, usually occurs as a consequence of Longs liquidating.

Market Profile Open Types:

Open Drive: If the market opens above or below prior day’s range or value area, then an Open Drive is dominated by responsive buying or selling back to prior accepted value. If the market moves away from the prior day’s range, then the open is dominated by initiative buying or selling. You want to detect this early and not trade against it. OTF is highly active and is accumulating/distributing aggressively.

Open Test Drive: Market opens, moves a short distance in one direction and then another trying to advertise for one side or the other to step in. This will usually test a prior key area and then push once it has gained conviction that nobody is left to oppose it. OTF waited for a test and has stepped in to executed in a fixed direction.

Open Rejection Reverse: Market attempts to continue in a prior direction and is met with fierce opposition and off to the races it goes. This is like an open drive, but it has gone to an area that did not meet with acceptance. OTAF has found an area of conviction to participant in the opposite direction.

Open Auction In-Range: Scalper’s paradise. Nothing has changed between this session and last. Market will likely be unfriendly to breakout traders and will reward those who trade from the extremes in. OTF is not present.

Open Auction Out-of-Range: Market opens outside of the previously traded range. There is a high probability of OTF action and these can be BIG days. There will be a higher level of conviction by responsive as well as initiative buyers or sellers.

Glossary:

Balanced Market: A rotational market where price movement is between a defined range.

Buying Tail: Thin volume area at the bottom of the Volume Profile indicating Other Time-Frame Buyer activity.

b Shaped Profile: A profile shaped like the letter b; thin volume at the top and heavier volume at the bottom. This is typically due to Long Liquidation.

Bull/Bear Line in Sand: The Bull/Bear Line in Sand is a simple way to establish Bias. It is a Key Price Level that is used to determine which side is in Control. Buyers are in Control if price is trading above this Level, and Sellers are in Control if price is trading below this Level.

High Volume Node (HVN): A price range with a high amount of volume (heavy acceptance). Typically, price does not slice right through these areas on first touch. These are Price Areas which saw heavy acceptance in the past, and price usually rotates around these areas before making its way through. Think of it as a golf ball hitting the rough; it doesn’t move through very easily. In the event that price slices right through it, that can be used as a valuable piece of information and is indicative of aggressive other time-frame activity. In other words, don’t fade it!

Initiative Buying: Buying above the Value Area. Simply, on the micro time-frame, this is buying activity when offers are being lifted. Buying at the Ask Price can be viewed as Initiative Buying.

Initiative Selling: Selling below the Value Area. On the micro time-frame, this is selling activity when bids are being hit. Selling at the Bid Price can be viewed as Initiative Selling.

Initial Balance (IB): The price range of the first hour of trading (8:30 AM CST – 9:30 AM CST in case of the E-Mini S&P 500 Futures). The Initial Balance High (IB High) is the 1st hour High, and Initial Balance Low (IB Low) is the 1st hour Low. These price levels tend to act as magnets and Support/Resistance areas during the day. Buying activity above the IB High indicates a strong market, and selling activity below the IB Low indicates a weak market. I am cautious of entering Shorts if price is trading above the IB High, and likewise, I’m cautious of entering Longs if price is trading below the IB Low. If price is well below the IB Low at one of my Strong Support Areas, I will use the IB Low as a Target to get out of my Long positions.

Long Liquidation: After an extended up move, when buyers decide to sell and get out of their Long positions. This typically results in a “b” Shaped Profile.

Low Volume Node (LVN): Price range with a low amount of volume. These areas represent a set of prices where there wasn’t much trade facilitation between buyers and sellers. The market usually rejects these prices quickly on a re-test; it either bounces off them quickly, or slices right through. Think of this as a golf ball hitting a glass window; it will either bounce off right away, or break through the window. Risk management and trade execution is even more important when entering trades at these areas.

Micro-Composite: This represents a profile built using several bars in a balanced range within the composite chart. Essentially, what we are trying to do here is find out what is going on inside a balanced set of daily bars. See just below for an image of what it looks like.

Mid-Point: This price level marks the center of the current day’s range. I keep track of the Mid-Point on the 24-hour Chart as well as the Day Session (Regular Trading Hours) Chart. This is an important Intraday Support/Resistance Level. Buyers are in Control above, and Sellers are in Control below the Mid-Point.

Normal Day: Small range extension beyond the Initial Balance.

Normal Variation Day: After the first hour of trading, range is extended two times the Initial Balance.

Neutral Day: A day when you have a range extension up and down (outside day). Neutral days form when the Other Time-Frame Buyer and Seller are involved in the same price range, and we get Responsive Buying below the range, and Responsive Selling above the range. This also indicates uncertainty in the market, and the day usually ends with little or no change in price.

NVPOC: Naked VPOC, meaning a VPOC that has not been tested during regular trading hours.

Open Auction: Price trades up and down around the Opening price without any clear direction.

Open Drive: Price moves directionally right from the Open.

Open Test Drive: Market opens and price tests a significant Support/Resistance Level and then turns around and drives in the opposite direction.

Open Rejection Reverse: When price opens too far outside the previous day’s Value Area, and is quickly rejected with the market reversing into the opposite direction (gap fill).

Opening Range: The price range established during the first minute of trading.

P Shaped Profile: A profile shaped like the letter P; thin volume at the bottom and heavier volume at the top. This is typically due to a Short Covering Rally.

Range Extension: Price movement beyond the Initial Balance.

Responsive Buying: Buying activity below the Value Area. In this case, price is viewed as too far out of value (too cheap), and buyers enter the market and push price back up towards Value. On the micro time-frame, this can be viewed as Buying at the Bid.

Responsive Selling: Selling activity above the Value Area. In this case, price is viewed as too far out of value (too expensive), and sellers enter the market and push price back down towards Value. On the micro time-frame, this can be viewed as Selling at the Offer (Ask).

Rollover Day:The following applies to many (if not most) futures contracts especially those from the Chicago Mercantile Exchange (CME) and Chicago Board of Trade (CBOT).

• Rollover is 8 days before expiration.

• Expiration is the third Friday of each quarter month (March, June, September, December)

• The contract letter associated with each month is: March=H June=M September=U December=Z

• Rollover is on a Thursday.

• Rollover is usually on the second Thursday of the month but will be on the first Thursday if the first day of the month falls on a Friday

• Volume shifts to the new contract at market open (09:30 EST) on Rollover day

• New day trading or swing trading positions opened on rollover day should use the new contract month irrespective of when you plan to close it.

• New swing positions might be better opened using the new contract if opened within a few days of rollover day.

Rotational Market: A market where price is moving up and down within a defined range. Also referred to as a Balanced Market.

Selling Tail: Thin volume area at the top of the Volume Profile indicating Other Time-Frame Seller activity

Trend Day: When the Other Time-Frame Buyer or Seller is in control from the open into the close.

Value Area: Price range/area where 70% of the trading activity takes place. The top of the range is the Value Area High, and the bottom of the range is the Value Area Low.

Value Area Low: Bottom of the Value Area

Value Area High: Top of the Value Area

Volume Point of Control (VPOC): The price level with the heaviest volume for the day. This is the price level with heavy acceptance by both, buyers and sellers.

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