Market Profile Concepts

Market Profile


And of course if you really want the secret to success:

Market Profile

A frequently asked question in our forum is: Where can I learn more about Market Profile?
The most common answer is to read Jim Dalton’s book Mind Over Markets.

Jim Dalton also wrote a sequel to Mind Over Markets called Markets in Profile.

A Market Profile is the arrangement and presentation of market action as a vertically aligned bell curve. Here is an example of a market profile:

1285.00 M
1284.75 HM
1284.50 DEGHM
1284.25 DEGHM
1284.00 DEGHM
1283.75 DEFGHIMN
1283.50 DEFGHIMN
1283.25 DEFGHIMN
1282.50 DFGJKLMN
1282.25 DJKLMN
1282.00 DJKLMN
1281.75 DJKLMN
1281.50 DLMN
1281.25 DLMN
1281.00 LMN
1280.75 LMN
1280.50 MN

Each series of letters represent a 30 minute time bracket and placing that letter against the price indicates that the market traded at that price during that time bracket.

Volume Profile

A Volume Profile is similar to a Market Profile inasmuch as they both show a profile (a bell curve) against the Y-axis of the chart to represent the most traded area(s) of the time period that they have been constructed against.

The major difference, a significant one, is that a Volume Profile is constructed using the volume traded at each price while Market Profile is constructed based on time brackets traded that the market traded at each price called TPOs.

Against each price on the vertical axis you will typically see a bar that represents the number of contracts that were traded at that price. This type of chart can also be normalized to show a percentage of the day’s total volume traded at that price. Volume Profile is agnostic about time that the market remained at each price.

The philosophy behind Market Profile is that the more Time Periods at Price=N in which an issue trades, the more significant is that price. Volume Profile does not care when an issue trades at Price=N, it cares only how much of an issue trades at a particular price.

In theory, an issue could trade one contract at Price=N in each of 48 1/2 hour time periods during a trading day. The same issue could trade 50,000 contracts at Price=X in only a single 1/2 hour time period. In Market Profile, Price=N would appear as a “peak” and Price=X would appear as a valley. In Volume Profile, X would be the “peak” and N would be the “valley”.
Opening Price: If the opening price is higher or lower than the previous days close this creates a gap on a price chart. In market profile, this gap represents a shift in market sentiment. Like all gap, the greater the gap the more its significant. For example, a market gapping up 80 points on a CCI economical news has alot more significance than a market gapping up on 30 points with no news and light premarket volume. The first gap has a chance of being a contiunation gap while the latter one has a high probability of a gap fill.

Opening Price in relation to the value area: Here is a rank of market balance vs market imbalance. If price opens above/below value and the previous days range, this creates a complete market imbalance. This offers a high risk but high reward trading opportunity. If price opens above/below value but within the previous days range this indicates a market imbalance but not as significant as the earlier example. This creates a medium risk and medium reward trading opportunity. If price opens within value and within the previous days range, this indicates a complete market balance. Unless price extends above/below value, this creates a low risk but low reward trading opportunity.

Previous days close in relation to todays open: Any late afernoon rally or decline can mean two things: either the longer time frame participant has stepped in to buy/sell aggressively or the short term traders are liquidating their position. To understand the difference is crucial. For example, let’s say the previous days late afternoon market action was a rally and price closed at the upper extreme of its range. This could indicate a short covering which fueled a rally or actual longer-time frame buyers stepping in. The opening price action is crucial to understanding this. If prices can remain above the previous days high and value high, this means that the rally was valid and longer time frame buyers was present. The previous days high and value high will act as support. However, if the markets opened above the previous days high and was quickly rejected falling below value, this indicates short covering. Understanding price acceptance from rejection is crucial.

Look for market excess: Market excess exists when prices have extended too far above/below value. Other time frame buyers or sellers will enter aggresiviely to return price back into value. A single print tail below/above value is a good sign of market excess. On a price chart, this is where prices find support/resistance with a quick reversal never to test that support/resistace again.

“Excess is created when the other timeframe recognizes an opportunity and aggressively enters the market, returning price to the perceived area of value.” from Mind over Markets

Why are these levels important? They can as key future support and resistance points. These levels represent price rejection. No time = no acceptance.

Previous days close: If the previous days close remains in value, this indicates market balance. If the close remains above/below value this indicates market imbalance.

If the markets rotated above and below the opening price to close at its upper extreme, we have a temporary victory by the bulls. If the markets closed at its lower extreme, we have a temporary victory by the bears.

Understanding the POC: The Point of Control is the price level in which the highest volume occurred. This can act as a key support or resistance point. This is also commonly used as a level to place stops.

Value high and value low: These are two important pivots when using market profile. When prices are trading within value, the value high will act as resistance and the value low as support. If prices do break out of value, the VAH will act as support and VAL as resistance.

Opening Range: Also known as the initial balance. If the initial balance is narrow in the morning session, any break above/below willl most likely be the trend for the day. A wide initial balance can indicate a market rotation from the upper range to the lower range for the trading day.


(b) Shape Profile: A profile shaped like the letter (b). Skinny at the top and fat at the bottom. This formation is typical of long liquidations.

(P) shape profile: A profile shaped like the letter (P). Skinny at the bottom and fat at the top. this formation is typical of short covering rallies.


Types of Days

Normal Day – Profile structure in which prices auction between two extremes. Extremes are usually established in the opening hour causing a wide initial balance. Prices will then rotate back and forth without upsetting the initial balance.

The normal day has a wide initial balance price range that equals approximately 80% of the day’s total range. This is the most common pattern.

Normal variation of a normal day – Similar to a normal day in which prices auction back and forth between two points. However, the initial balance is usually narrower until the other time frame market participant will extend the range sometime during the trading session. The initial balance is usually upset during the morning session.

Trend day – Buyer or seller remains in control the entire day. Prices usually will not return to the opening price. There is a high level of confidence attracting new market participants fueling the rally or decline. The trend day has a small initial balance representing less than 25% of the entire day’s range.

This profile shows domination by either buyers or sellers with long range extension in one direction. The trend day will close within 5 to 10% of its daily high or low price.

Double distribution trend day – Similar to a Trend day except for a quiet morning session. Confidence among market participants are not as strong as a Trend day. However, later in the trading session strong buyers or sellers enter the market extending the range. Example: late afternoon decline

Nontrend day – Usually occurs before a significant news. Low confidence among market participants causing prices to remain choppy with no direction. Usually a good day to take a break.
This structure has a small initial balance that contains the entire day’s price range.  A non-trend day typically occurs when the market is resting or stagnating.
Neutral day – Both sellers and buyers are present but hold similar opinions on value of price. Prices will usually rotate below and above the opening price. The market is in balance. This profile is not characterized by its initial balance but by a range extension in both directions and a close near the center of the day’s range. This structure demonstrates lack of buyer and seller conviction.

Objective and Subjective Elements in a Market Profile

The objective part of a Market Profile is the profile display. This comes directly from the data itself, creating TPO’s (either from LDB or tick data (11)). A key element is the Initial Balance, the range and price location of the first hour of trading.
Subjectively, Steidlmayer recognized a few behavior patterns or ‘Day Types’ in the early part of the day (tied to the Initial Balance), defining 3 types (CBOTMPG1, Pg 12) and later, 4 (CBOTMP2, PG 4, 12). Each type developed certain characteristics, telling which sort of trader is in control (short term traders, longer traders, etc.). Mind Over Markets lists 9 day types . See reference 10 for a discussion of this point.
Day types, of course is chart reading and forecasting. The well known problem with interpreting charts is the multitude of potential interpretations for most any chart. Mastery theory offers some hope for traders who are willing to spend the time and effort in understanding the auction market environment. But that path can well take 10,000 hours of training. A large part of CBOTMPG1 and more particularly, CBOTMPG2, is devoted to ‘reading’ the profile as it develops throughout the day. CBOTMPG1 suggests that it will take six months to a year to learn the Market Profile methodolo

Limitations on Market Profile

1. The primary condition for a valid profile is a normal, equilibrium distribution. If the market is not in equilibrium there is no valid POC or standard deviation. A simple visual examination will often be enough to certify that the distribution is abnormal: the day may have two distributions (two peaks) or the trading may be directional, etc. Although unfit, non-equilibrium data can still be operated on as usual by a computer program, the results are likely meaningless or misleading. Most traders who use Profiles seem oblivious to the requirement for normality.
2. Even in overall equilibrium markets there can be days in which the market prices jump out of bounds (false breakouts) and then return later in the day or the next day. A single day’s Profile does not provide a reliable measure of market condition. Research indicates that a three day measure is the minimum preferred.
3. Markets have changed since 1985/1991. Pits are approaching extinction. In 1985 and earlier, trading by members in the pits was by open outcry; commercial traders were in view and the ‘trade’ dominated the markets. Today (2011) there are few pits and public traders dominate the trading volume. Certainly, an intelligent and alert trader like Steidlmayer in the pit had much more to go on than just the Profile graphic available today.
4. Profiles were defined to use LDB data. Point of Control is the price at maximum cleared volume. Few traders today have access to LDB data.Research on cleared volume being substituted by TPO’s found the TPO’s were reliable in locating the Point of Control. The Meta-Profile Point of Control from TPO’s is not an exact duplicate of the Market Profile Point of Control . Users of the Meta-Profile need to be aware of the differences and their potential differences in trading.

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