Market Profile - Strategy And Rules

Market Profile – Strategy And Rules

Navigating the ever-changing world of financial markets can be a tough task, even for experienced traders, which is why tools like the Market profile can be a game changer for detailed price analysis. What do you know about the market profile?

A Market Profile is an intra-day charting method created by J. Peter Steidlmayer to display market activity, including price, number of trading activity (which represents volume), and time on a single chart. This charting method displays price levels on a vertical axis (y-axis), and the number of trading activities at each price level on the horizontal axis (x-axis).

In this post, we will take a look at everything you need to know about this indicator: what it is, how it works, and how you can improve your trading strategies with it. Read on!

Table of contents:

Key takeaways

  • Market Profile is an intra-day charting method developed by J. Peter Steidlmayer to visualize market activity.
  • It combines price, trading volume, and time on a single chart, offering a comprehensive view of trading dynamics. The chart displays:
  • Price levels on the vertical (y-axis)
  • Number of trades or volume on the horizontal (x-axis)
  • The structure forms a bell curve, with dense activity in the middle, tapering off at the extremes.This visualization helps traders identify heavily traded price levels, known as “smart money” accumulation and distribution.
  • Market Profile is useful for locating key market levels, helping traders understand transitions between market imbalance and equilibrium.
  • More indicators are available if you click here: best trading indicators.

What is Market Profile in trading?

A Market Profile is an intra-day charting method created by J. Peter Steidlmayer to display market activity, including price, number of trading activity (which represents volume), and time on a single chart. This charting method displays price levels on a vertical axis (y-axis), and the number of trading activities at each price level on the horizontal axis (x-axis). The trading activity part is structured in a bell curve style, with a fat middle and thining off at the extreme.

With price, volume, and time data merged in one graphic display, offering a detailed view of market activity, including most traded price levels, the market profile tool enables experienced traders to easily observe smart money accumulation and distribution in the market. Traders can use it to anticipate key levels of interest in the market, as it shows where the market moves from imbalance to equilibrium and vice versa.

Market Profile trading strategy – rules, settings, and returns

A backtested strategy is coming shortly.

Market Profile – trading strategy and trading rules

A trading strategy based on Steidlmeyer’s Market Profile is pretty difficult to code. Instead, we rely on backtests done by others.

How does Market Profile differ from technical analysis?

Market Profile differs from traditional technical analysis in that it merges the price, volume, and time data in one graphic display. This is unlike the usual technical analysis where price/time and volume/time data are provided separately.

However, the market profile is still a form of technical analysis as it tries to use price, volume, and time analysis to predict how the market will move in the future based on how it traded in the past. The tool is very unique in the way it shows the price levels the market traded and the volume of trading at each price level, thereby showing possible levels of balance (equilibrium) and imbalance.

What is the Point of Control in the Market Profile?

In market profile analysis, the point of control is the term used to explain the price level at which the highest number of trading activity took place during a given trading period, which is often a week in most market profile charts.

At the point of control, there is equilibrium between buyers and sellers. If the point of control is located around a key support or resistance level, the significance of that level is high, as the market may bounce off from there in the future. When that happens, traders may trade the reversal from such levels.

What does ‘value area’ mean in Market Profile?

In a market profile, the ‘value area’ refers to the price range within which a significant portion of the trading activity has taken place. Usually, approximately 70% of the trading volume occurred during the given period. The price moving away from the value signals a potential trend continuation or reversal, and this helps traders identify emerging trends.

It is also possible to combine the information with support and resistance areas to identify trading opportunities.

How can the Market Profile identify trading opportunities?

The market profile can identify trading opportunities by showing areas where the market traded intensely without much displacement, signifying a sort of balance in the market at that level. The price is likely to bounce from such levels and move away — that is, moving from areas of balance to imbalance.

You can use such information to predict price movements. For instance, if the area of balance — point of control or value area — is close to a support/resistance area, you can look for reversal candle patterns when the price gets there and trade the bounce off from there.

What are TPOs (Time Price Opportunities) in the Market Profile?

In the market profile, TPOs refer to the vertical bars or columns that show the price range traded during the given period. It represents the price distribution during the specified time, showing the price levels where the price has spent the most time.

That is, TPOs show the areas where the market is trading most of the time. For instance, if TPOs are clustered around a particular price level, it means that traders are actively trading at that level. So, with TPOs, you can analyze the amount of time-based trading activity for each price level the market traded at over the given time period. this helps you identify potential support and resistance levels and areas of price consolidation.

How do you read a Market Profile chart?

You read a market profile chart in combination with price action analysis. The market profile chart will help you easily identify and confirm significant price levels that you should pay attention to when the price trades toward the area.

So, you mark these areas of balance and note the areas of imbalance where the price is likely to trade when it is coming out from those areas of balance. Then, with price action analysis — especially candle pattern — you can watch how the price behaves at those key levels.

Why is Market Volume important in Market Profile?

Market volume is important in the market profile because it shows the quantity of trading that takes place at each price level. this information can help you understand how significant certain levels are to market participants.

Since the market has memory, the price may react at those levels again. Another reason why the volume is important is that it can help show the significance of price movements.

How does the Market Profile help with price prediction?

The market profile helps with price prediction by showing the distribution of trading activity across different price levels. The bell shape of the market profile chart shows areas where the market traded intensely without much displacement, which indicates a sort of balance in the market at that level.

Since the price is likely to bounce from such levels of equilibrium and move away to areas of imbalance, traders can use the chart to predict future market movements, especially when combined with price action analysis.

What role does time play in Market Profile analysis?

The role of time in market profile analysis is very significant, as it shows how long the price traded at a particular price level.

When combined with the volume of trading at that level, it can tell whether that price level is significant or not — that is, whether it is a value area or a point of control, which are key areas to keep in mind when analyzing the price action properly.

How do market trends affect the Market Profile?

Market trends can affect the market profile since they affect the movement of the price, which is what shows up in the market profile as price distribution over different levels. For instance, in a trending market, the value area would shift in the direction of the trend, indicating a shift in momentum in that direction.

On the other hand, when the market is in a consolidation, price distribution will be limited to a certain range, indicating a sort of balance in the market.

How can the Market Profile be used for day trading?

To use the market profile indicator for day trading, you have to learn how to analyze both the market profile chart and price action. The market profile will show you value areas and significant levels (points of control) in the market, which you have to have in mind when doing your price action analysis.

For instance, if the point of control corresponds to a known support or resistance level, you can look for reversal candlestick patterns around there to find day trading opportunities.

What are the best tools to use with Market Profile?

The best tools to use with the market profile are support and resistance levels, trendlines, chart patterns, candlestick patterns, and volume indicators. These tools, when combined with the market profile, will help you identify market trends and potential reversals.

While the market profile can help confirm some key levels in the market, tools like candlestick patterns can tell you how the price reacts at such levels.

How does the Market Profile handle market volatility?

The market profile handles market volatility by showing you how the price movement is distributed over a given time. So, it is possible to understand the level of market volatility by studying the market profile. If the price is spiking about around a certain level, that level may later show up as a value area or point of control. It shows that the market found balance around that level.

Can the Market Profile be applied to all types of markets?

Yes, the market profile can be applied to all types of markets, including the spot forex market, because it is majorly based on price movements, time, and trading activity at any price level, and not directly the volume of transactions.

It gives information about price on the y-axis and time on the x-axis and uses the number of trading activities at a particular level and time spent there to estimate volume. Thus, it can be applied to any market that shows price activity.

How does the Market Profile analyze market depth?

The market profile does not analyze market depth. Each is focused on a different aspect of the market. While market profile focuses on the distribution of market trading activities or executed orders (market orders) at various price levels, market depth focuses on the distribution of limit orders.

So, you cannot directly use the market profile to analyze market depth, but you may be able to use it to know if there were so many orders at a price level.

What is the initial balance in Market Profile, and why does it matter?

In the market profile, the initial balance is the price trading activity during the first hour of a trading session. Basically, it is the price range formed during the first two brackets of the market profile. It is formed by the activity of early traders who jumped in at the market open.

Initial balance matters because it helps you to anticipate the day’s potential trend, as it’s a reflection of early market consensus of the price direction. It serves as a foundation for the day’s trading activity. You can leverage it to plan your strategies in line with the market momentum and improve your trading outcomes.

How do you set up a Market Profile trading strategy?

You set up a market profile strategy by first understanding the charting technique: its strengths and weaknesses. Then, you look for other complementary tools to combine with it to formulate a reliable trading strategy.

Those tools can be trendlines, support and resistance levels, and candle patterns. Next, you backtest your strategy to be sure it has a positive expectancy.

What are common mistakes beginners make with Market Profile?

Common mistakes beginners make with the market profile include:

  • Starting to trade with the market profile without first understanding how it works
  • Trading with market profile as a standalone strategy and not combining it with other analysis tools
  • Misinterpreting the levels and taking them for trade signals
  • Not having a risk management plan

How do auction theory principles apply to Market Profile?

Yes, auction theory principles apply to market profile in that price movement works like an auction, and market profile only maps the distribution of that movement. The market is an auction process that is affected by supply and demand, just as every other auction. When the price is going to go up, it keeps going up provided there are buyers who are willing to buy at higher prices.

Similarly, when the market is going down, it keeps going down as long as there are willing sellers at lower prices.

How does the Market Profile relate to supply and demand?

Market profile is related to supply and demand, as supply and demand are what determine how the price moves, and the market profile only maps how the price moved and where the price stayed the most.

The market profile shows areas of balance and imbalance created by demand and supply. Excess demand relative to supply pushes the price up while excess supply relative to demand pushes the price lower.

What is a composite Market Profile and its use?

A composite market profile is one that supports two profiles: the TPO profile and the volume profile. The TPO (time price opportunity) profile shows the distribution of trading activity at different price levels. for instance, a TPO profile row of 50 means that the market has traded at that price level 50 times. The volume profile, on the other hand, shows volume distribution by price levels.

For instance, a volume profile row of 50 implies that there have been 50 contracts traded at that price level. This can only be useful for markets with true volumes, such as stocks and futures.

How can Market Profile guide entry and exit points?

The market profile can guide entry and exit points by showing price levels where the market is in equilibrium. If the price is moving away from such a level, that can be an entry signal, especially when supported by the right candle pattern and volume.

Conversely, the price trading to such a level could be a signal to exist and it is likely to be held there or even reverse.

What are the anomalies in Market Profile charts?

Anomalies in market profile charts are price levels that lack symmetry, creating an abnormal shape in the market profile. They represent structural weakness, and since they’re created by time and price interaction only, they may not show up on volume profiles.

Identifying anomalies is often the first step to seeing the background context in the structural development of the profile. The price tends to revisit those levels to fix things up.

How can the Market Profile be integrated with other trading indicators?

You can integrate the market profile with other trading indicators by first understanding how the indicator works so you can know other trading indicators that can complement it. With that information, you can combine it with those other indicators to create a robust trading strategy.

What historical data is important for Market Profile analysis?

The historical data that is important for market profile analysis is the price and time. However, that is only if you are working with the traditional market profile, not the composite one. With the composite market profile, you also need the volume data for your analysis.

How does Market Profile assist in risk management?

Market profiles can assist in risk management by showing you or confirming potential areas of support or resistance beyond which you can put your stop-loss orders. However, the indicator does not tell you how much to risk per trade, the position size to carry, or how to trail your profits. You have to have a risk management plan that guides you.

Can the Market Profile predict market reversals?

Not directly. While the market profile does not directly predict market reversals, it can show you or help confirm potential areas of support or resistance where the price may reverse. But to predict price reversals at those levels, you need to combine it with price action analysis. For instance, a reversal candle pattern at such a level might indicate a potential market reversal.

What are the limitations of using the Market Profile in trading?

The limitations of using the market profile in trading include:

  • It is complex and may require a steep learning curve.
  • Its interpretation can be subjective, so there is a risk of misinterpreting the data and making bad trading decisions.
  • It relies on other indicators or tools to define trade entry and exit criteria.

Where can you learn more about Market Profile?

Where you can learn more about Market Profile includes trading blogs like therobustrader.com and tradingstrategies.com. But we recommend reading J. Peter Steidlmayer’s book on market profile: “Trading with Market Profile, 2nd Edition”.

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