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Market Profile – Understand Your Structure and Fundamental Concepts

Market Profile is a graphical market reading tool created by J. Peter Steidlmayer in the early 80’s, with the aim of assisting the trader in understanding and understanding the markets.

Far from being a ‘trading system’ or some kind of buy and sell setup, the market profile function is simply to organize the trading data of the markets in an understandable and appropriate way for the decision making of traders and investors.

Since its inception, The Market Profile is disseminated together with a series of theoretical and operational concepts in order to explain its usefulness and practical application to the general public.

In this article, you will learn about these fundamental concepts of Market Profile as they were disseminated and synthesized in the original works of its creator, Peter Steidlmayer.

If you want to save this article to read later, download here: (PDF) Market Profile – Fundamental Concepts

Market Profile Sources

Peter Steidlemayer was born into a family of farmers and learned to trade in agricultural markets with his father, who was a farmer and active trader. Thus, from an early age, he developed a practical and objective view of the negotiation processes.

He began his career as a trader in 1960 in the trading pits of the Chicago commodity exchange, CBOT.

Early in his career, Steidlmayer sought to find a “real measure of value” to interpret the conditions of the markets he operated and thus execute his trades with greater confidence.

In this search, he was influenced by the works of Benjamin Graham and David Dodd related to value analysis for investments and also by the concept of ‘minimum trend’ developed by graphist John Schultz.

In addition to these influences and his background as a negotiator, Steidlmayer studied statistics at the University of Berkeley, where he learned the concept of the Bell Curve or “bell curve”. According to him:

“(…) I had already learned, by observation and conversations with my father, that the relationship between price and value was the key to understanding the markets – price away from value usually represents opportunity. (…) The idea of using Graham and Dodd’s concepts along with the bell curve clearly intrigued me.” Pag.18 Steidlmayer on Markets – 2nd edition

From these influences and his experiences as a trader, Steidlmayer was developing a peculiar way of annotating what he perceived from the markets.

Initially, the purpose of these notes was simply to assist in their own operations in the market.

However, in the early 1980s, when Steidlmayer became director of CBOT, the Chicago commodity exchange, he was invited to lead the project of implementing a revolutionary way of transmitting market trading data, the Liquidity Data Bank.

Liquidity Data Bank Vesão Original Otimozada
Liquidity Data Bank report example

* CTI is an abbreviation of ‘Commodities Trader Identification’ or subsequently ‘Customer Trader Indicator’

Liquidity Data Bank was, in short, a report issued only at the end of the day by CBOT that showed the volume traded at each price level, the percentage traded by each participant type (CTI*) and the Market Profile of the day.

It was from this report that the market profile and its fundamental concepts became known worldwide and applied by thousands of individual traders and participants of proprietary tables.

The Market Profile Chart

The simplest way to understand how the Market Profile chart works is to compare it initially to a normal 30-minute candlestick chart.

01 Graf 1
30-minute Candlestick Chart

In this figure each candle represents 30 minutes of trading aligned horizontally on a time scale.

What Market Profile does, initially, is replace these candles with letters that represent these 30 minutes sequentially:

A = 0 to 30 min

B = 30 to 60 min

C = 60 to 90 minutes

And so on, forming the graph we can see below:

02 Graf 1
Example of Market Profile Chart ( With ungrouped “letters”)

However, this form of representation is not yet the Market Profile, but rather a way to explain how it is formed.

To have the Market Profile chart, imagine that these letters are “pushed” to the left as if we were in a Tetris game.

By doing so, finally, we understand the formation of the Market Profile, exemplified in the chart below:

03 Graf
Market Profile Chart

Note that these three charts above represent the same market, however, in different ways.

It is then evident in the use of Market Profile, a formation of regions where price has traded for longer, forming what we call ‘regions of value’, a concept derived, as explained, from the statistics and studies of Graham & Dodd applied by Steidlmayer to trading.

In Market Profile, the value is formed by the equation: Price + Time = Value

This simply means that the regions where the market has traded the longest are the regions of value.

Below is a use of Market Profile in conjunction with a 30-minute candlestick chart, already highlighting the value area (in yellow), a concept you will understand best in the next paragraphs.

04 Graf 1
Market Profile Chart with Candlestick Charts (30 min)

The Market Profile Framework

The Market Profile structure is formed by TPOs.

TPO is an acronym coined by Steidlmayer himself to represent each of these letters that are plotted on the chart.

A good translation would be like Time, Price and Opportunity(Time Price Opportunity).

Let’s look at these three components of the TPO explained in more detail.

For this, we will use the analogy with the auction, inspired by the studies of one of the biggest market profile routs and Steidlmayer’s contemporary, James Dalton.

If you want to save this article to read later, download here: (PDF)Market Profile – Fundamental Concepts

(The view of markets as an auction is at the root of the interpretation of market profile data and is known as Auction Market Theory.)

In an auction we have the auctioneer, who announces the prices, we have a time of start and end of the auction and also the advertised prices.

So by making this comparison of the markets working as auctions, we have to:

The tradedP functions as an auctioneer announcing all opportunities.

The marketopening and closing T-empo functions as a regulator of these opportunities, creating the various operation timeframes.

The Volume traded at price levels measures the “success” or “failure” of the advertised opportunities.

With these concepts in your head it becomes clearer to understand why the name TPO (Time, Price and Opportunity).

For example, when a price is advertised, the volume traded there will measure the acceptance or rejection of the price by market participants.

A quick rejection means a failure, that is, there is no price continuity in that direction and may indicate a reversal point.

Market Profile Fundamentalconcepts

Far from the idea of exhausting studies on Market Profile, the intention of this article is to present an overview of its origin and main foundations.

The fundamental concepts will be presented with their Nomenclature in English together with the translation into the Portuguese.

It is very important to master these concepts in English to facilitate the study.

So let’s go to them:

Initial Balance (Equilíbrio Inicial)

Graf Ib 1
Initial Balance Highlighted in Purple

Initial Balance is represented by the first two trading periods, i.e. the letters ‘A’ and ‘B’ (purple band next to TPOs). This corresponds to the first hour of trading.

Why is this first hour called that?

Regardless of the asset or derivative you are trading, overnight many things happen and both small and large players adjust their positions at the beginning of the day, or simply “test” market interest levels.

Therefore this first hour is usually marked by a lot of volatility and usually schedule stake in an initial trading region.

It is important to highlight that each market has its particularities and this concept of Initial Balance does not need to be adopted mechanically, and the Initial Balance can last more or less than the first hour and, in certain situations, not even to graduate!

The Initial Balance region can also give us clues as to how the day will unfold, whether it will be a side-by-day or trend day.

Range Extensions (Extensões do Range)

Graf Re 1
Range Extensions highlighted in purple

Range Extensions are vertical movements that “widen” the initial trading region of the asset, the Initial Balance (evidenced by the blue rectangles in tpos C and D).

By “breaking” this area of balance of the asset can reveal new or big players entering the market.

As a balance area is broken leading the market to imbalance, it may be that large players are entering “the game”, since it is they who have the power to actually lead the market to new prices.

Extensions are forming throughout the trade and may or may not lead to a new area of value.

Value Area (Área de Valor)

Graf Va 1
Value Area highlighted in yellow

The Value Area is the Market Profile region composed of 70% of the volume of TPOs of a sampling of the traded asset.

Remember the bell curve commented at the beginning of this text? Well, the Value Area represents approximately a standard deviation from the “sampling” of TPOs.

We can say that this area is the price region where buyers and sellers most agreed to do business, where prices are seen as fair to both sides and have been negotiated longer.

According to James Dalton:

“Regardless of the time frame you are analyzing, when prices move away from an area of value, there can be either an acceptance – represented by the accumulation of TPOs at the new price level, which effectively changes the shape of the Market Profile and shifts the value area – or a rejection, when prices return to the value area with little change in the volume of distribution” (Markets in Profile).

It is important to highlight that in the original literature there is no concept of VAH (value area high) and VAL (Value area low), much disseminated by some people when referring to the concepts of Market Profile.

Point of Control (Ponto de Controle)

Graph Poc 1

The control point (blue line), or POC, is the price that was traded for the longest number of time, represented by the largest row of TPOs.

We can see it, too, as the fairest price to do business, since most of it happened at that price level.

Extremes

Ext Graf 1

Extremes (green rectangles) are regions where the market has been in imbalance, i.e. where prices have been seen as ‘unfair’ by participants.

These regions are below and above the value area. These are regions where there was rejection of the market, where the market was trading for a short time.

From this concept of extremes derives the idea of ‘buying tails’ and ‘selling tails’ that happen when a long tail is formed, with a maximum of 2 TPOs wide, at the ends of the range.

Graf Tails 1

Initiative vs. Responsive Activity (Atividade Iniciativa vs. Responsiva)

Graf Ini 1

The concepts of ‘Responsive Activity’ or ‘Initiative’ were originally used to qualify the behavior of market participants in relation to the value area of the previous day.

However, it is possible to extrapolate this analysis also in relation to the references of value areas of larger periods.

The concept is simple: every time the price is traded above the value area, we say that buyers are taking the initiative to take prices to new values, while sellers are responsive, that is, they are responding, with sales, to this price higher than the value.

The reverse is also worth: sellers who sell below the value area are initiatory and buyers are initiatory. So we have: Above the value area: ‘Initiative Buyers & Responsive Sellers’

Below the value area: ‘Initiative Sellers & Responsive Buyers’ So the trend is that responsive activity will bring the price back to the value area, just as the Initiative activity leads the price to extrapolate and seek new acceptance regions.

Important: be careful not to fall into the error of confusing the concepts of Initiative/Responsive activity, which are related to market behavior in relation to value regions, with the concepts of aggression or absorption that are used in the analysis of the flow of orders.

Final considerations

The knowledge you have just acquired by reading this article should be considered only as the beginning of a great walk.

In addition to the concepts and examples shown here, in a nutshell, there are still many insights and insights that can only be learned from practice and the actual experience applied in your day-to-day as a trader, making your own decisions and learning from the endless changes in the market.

Proficiency in day trading requires, among other skills, a deep knowledge of the market, its structure and trading logic, items where market profile studies play a fundamental role.

I hope that with this article i have just read, I have helped you to have a clear and objective view of the importance of Market Profile and its fundamental concepts.

Good studies and good trades!