The Fundamentals

If you’re unfamiliar with Auction Market Theory or the Market Profile tool, you may not understand or be aware of specific terms I use in my analysis. While my goal is to write my analysis in a way you do not need to be an expert on AMT or the Market Profile to understand it, a basic understanding will help you tremendously. I created this page to help you form a basis of understanding in how I approach my analysis and to use it as a reference of common terminology.

The Foundation

The foundation of my analysis is a concept called Auction Market Theory, or AMT for short. AMT is a straightforward concept, and in all of my experience, it does the best job of describing how financial markets work. The basis for AMT is this: a market’s sole job is to facilitate trade. It facilitates trade through an auction process where participants engage in trade by buying and selling the asset. Like all auctions, if the price of an asset auctions too high, participants will decide it’s too expensive and refuse to buy until the price auctions back down to what they believe to be a fair price. Likewise, if the price auctions down too low or “too cheap”, participants will stop selling until the price auctions back up to a price they deem to be fair. Thus, participants' behavior and belief in what “fair value” is in a market will cause an asset's price to move, seeking out areas of price where the most trade can be facilitated.

How do we know what is considered “fair value”?

This is a good question. The answer is time. The Market Profile tool allows us to see this information.

Time is the market’s regulator. It validates price and regulates opportunity. It is said to regulate opportunity because the location where price spends the least time is usually the location with the best trade opportunity and the largest profit potential for a trader.

The area where price spends the most time facilitates the most trade, and thus, since participants agree on the price most often in this area, this is the price range with the fairest value. The area where price spends the most time is also where the worst trade locations are usually located, which results in the highest risk and least profit potential for a trader.

The Two Golden Questions

Every day when I sit down to analyze the market, there are two questions I am trying to answer:

“In what direction is the market trying to go?”

and

“How good of a job is it doing going in that direction?”

All of my analysis is done with the goal of answering both of these questions to the best of my ability based on the information available to me. It is not always possible to answer both questions with high confidence, but when you can, you are in a great position as a trader.

Important Terminology

Intraday Participants

Participants whose timeframe for trades is the same day. These traders do not hold trades overnight; they are flat and completely out of all trades by the market close each day. Intraday participants rarely move the market; they primarily provide liquidity to other timeframe participants who do move the market.

Other Timeframe Participants

Participants whose timeframe for trades is longer than the same day. They are referred to as “other” because there is no way to know how long their time horizon may be except that it is something other than the same day. These other timeframe participants may hold their trades for days, some for weeks, and some for months. Other timeframe participants are almost always larger financial entities such as investment banks, hedge funds, or companies that need to conduct business in the futures market for business purposes. They tend to participate in the market in much larger quantities than intraday participants, making them the participants who can move the market substantially.

The key to success in trading the futures market is being able to spot if other timeframe participants are active in the market, and if so, which direction they are driving the market, and getting on the same side as them.

Range

A session’s range is the entire height of the day’s price action, spanning from the day's high to the day's low.

Value Area (VA)

The value area for any day’s session is the area of the day’s range where price traded for roughly 70% of the day’s session. This area is important because where price spent 70% of its total time in a given session is where the most trade was facilitated for that day. Thus, this is where the fairest value was found in the day’s session.

TPOs

TPO stands for Time Price Opportunity. A single TPO is one 30-minute block of time during the day’s trading session. TPOs start at the letter A and go alphabetically until the session ends. In the Market Profile, price areas with more TPOs than others are called levels of acceptance. The reasoning behind this is if price spends more time at certain price levels, then more trade is being facilitated at that price level, indicating that market participants are accepting it as fair value. Conversely, price levels where the least amount of time is spent are referred to as levels of rejection since these levels are where trade was not being facilitated due to participants rejecting price as being fair value.

Opening Range

The standard opening range is the price range in the first minute of the day’s trading session. Some traders use this as a sentiment indicator off the open.

Closing Range

The closing range is the price range during the last 30-minute period of the day’s trading session. It is the last Indication of sentiment for the day and is often used by traders as a reference point for the following day’s session to indicate whether sentiment has changed from the prior session.

Initial Balance (IB)

The initial balance, or IB, is the price range for the first hour of the trading session. This is the A and B TPOs in the market profile. Some traders view the IB as a base for the day’s trading session. If the IB is too narrow, it is easier to “knock off balance” and the odds are greater that the base will be upset at some point, and price will auction substantially in one or both directions. If the base is wide, it will provide a more stable foundation for the day’s auction and is likely to maintain the extremes for the day.

Point of Control (POC)

The point of control is the longest line of TPOs closest to the center of the range in the Market Profile. This is the price where the most activity occurred during the day’s session and is, therefore, the fairest price in the day's timeframe.

Tails

Tails, or single-print tails, to be more specific, appear as two or more single TPOs on the market profile at the edge of the range. They are often referred to as excess. They indicate strong rejection at a price level by other timeframe participants. To get 2 or more single TPOs, the price has to move to a certain level and then reject back in the opposite direction within a 30-minute period. This swift price movement indicates a strong opinion by other timeframe participants that a price level is not considered fair value. For this reason, tails often indicate an area of significant support or resistance and should be paid attention to by traders.

Tails are one of the most reliable indicators of other timeframe participation in the market.

Gaps

A gap is exactly what it sounds like: an empty area on the chart where price did not auction through. Most gaps in the futures market are created by overnight activity that results in price moving away from the prior day’s range and opening with a gap. I refer to this in my analysis as opening out-of-balance. You may have heard the saying, “The market fills all gaps.” Nothing is 100% certain in the markets, and any absolute statement such as this should always be treated with suspicion. I can go back in time on my charts and find gaps that have never been filled. However, I do believe, based on my own personal experience, that the market often tests gaps. There is enough historical evidence in the charts to make the case that the market often does not like to leave gaps untested. It is as if participants need to know if there is any business to be done in these gaps before having the confidence to return to auctioning price in the direction that created them. I find them important to mark on my charts and pay attention to until they are either tested or price moves so far away that I feel they are no longer relevant.

Gaps are also known as “invisible tails” due to the initiative activity that created the gap, which would show up as a tail on the profile if it had happened during the day’s session. They can also provide the same level of support or resistance as a tail.