Linda Raschke presents:
Auction Market Theory and Technical
Analysis: Market Profile meets
Wyckoff
AAPTA – May 2012
Copyright © 2012 Linda Raschke and LBRGroup,Inc.
All rights reserved.
Auction Market Theory (AMT)
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Price /Time + Volume = Value.
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The function of the market is to facilitate trade.
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Probing higher prices attracts sellers and probing lower
prices attracts buyers. The rotations up and down are the
process used for “price discovery” , or to discover the price
that both sides agree upon, thus establishing “value”.
Auction markets are a dynamic process. AMT helps to
explain how markets work and provides reference points
where decisions can be made, but is not meant to be a
forecasting tool.
Auction markets are a complex, dynamic system. AMT
provides a framework to understand the current market
situation (balancing or trending) or is it starting to
transition from one to the other?
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Auction Market Theory (AMT)
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Value is based on a perception of “fairness”. When the
market spends very little time at a particular price with
minimal volume, the price is considered to be “unfair”.
Unfair levels show up as price rejection spikes.
For each time period, the market participants actions
determine what the “fair” price is or value for that time
period.
Vertical movement is called “one time-framing” where the
market is out of balance and all market participants want to
be on the same side of the market. This is the most
profitable trading opportunity. It represents a market out of
balance and is caused by a LARGE SHIFT IN CAPITAL.
The market can’t move too far from a value area without
the presence of the “Higher Time frame Player”.
Market Profile Charts
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Market profile charts show how much time a market spends
at a given price and give a visual as to how value is built.
A traditional tick chart shows the relationship between Price
and Volume at a specific point in time.
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The Market Profile “value area” is the price range where
70% of the total trading volume occurred (first standard
deviation).
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Price action naturally organizes itself into a series of bell
shaped curves as a market comes back into balance.
Market Profile Charts
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Is the market trending (trading vertically) or is it
nontrending (trading sideways)?
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A horizontal market has a test of a high (two data points)
and a test of the low, thus forming a trading range.
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Trading tactics for a range market are very different from
trading tactics for a trending market.
The Soybean market is transitioning from a balanced market to a trending
state. Each days value area (pink lines)is rising. Note the clues at the bottom
where the market closed above the day’s value area. After two 3-day
balancing bars, the price launched into trending action.
Beans now enter a consolidation period where “value” is established
at a higher level. The last 13 days of trading form a larger bell
shaped distribution profile.
The next jump up forms an even larger “value” area (which will be
shown in the next slide). Note how the market comes into a final
“balance” area before launching into the next trending leg.
Bean market composite volume distribution 3/5 to 4/29 showing first
balancing area, and then next larger balance area.
Here is what the corresponding bar chart looks like for July soybeans.
The building of “value” areas at higher levels is an important process
for sustainable trends.
This is what happens to a market that has failed to build value areas
along the way to support the rise in price. Note the area where price
fell back down to in order to find support.
The breakdown from this extended value area led to “onetimeframing” – a trending environment where all market
participants are sellers. What does the current structure suggest?
The Yen auctioned lower until it found a level where buyers were willing to
step in. A rotational environment developed (the market auctions up and
down until price comes back into balance). Value is agreed upon, at least for
the short term, between buyers and sellers.
Look how the auction process built a base. This is the compositie
profile chart showing the price distribution with volume. Current price
(noted by the dotted blue line) is now above the established value
area. Lets go back and look at a previous chart of the daily bars.
What was your first instinct upon seeing this daily bar chart?
Look how the value area has risen to a higher level. Current price is
at the far right of the chart. The area above the dotted blue line was
the one timeframing downtrending environment.
Price found support above the “high volume node” or newly formed
value area. This led to a new swing up above the previous high.
in.
This was a recent breakdown in the SPs on a 240 minute bar chart.
(April 15, 2012)
Price fell out of the upper value area and back into a previous trading
range. The price low came in where the dotted blue line is, the
lower end of the prior value area. Markets move quickly through
“holes” on the consolidated profiles.
The market found support and now it will start to fill out the “hole”
until a broader bell shaped distribution profile is developed. This is
the most common occurrence to see as a trading range is established.
Look how the volume profile has started to fill in the hole. The “point
of control”, or high volume node, has now shifted from above to
below the current price, serving as support. (1364)
Elements of Market Profile Structure
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Previous Day’s Value Area
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Initial Balance (IB = first hour range)
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Buying/Selling Extension (move outside of first hour’s
range)
Day’s value area. Point of Control = fair value for the day
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How does the day develop after early range? A “Normal”
day is when 80% of the range occurs in the first hour of
trading. This is the most common pattern. How trade
develops after the opening and after the IB tells us who is
in control of the market.
in.
The Canadian Dollar had an upside breakout from small balancing area at the top
of a broad value area. It is now starting to trend. Market Profile is not a
forecasting tool though - it can only follow the price action, give an indication
that a trend is transitioning back to a balance, or, indicate a “failed auction”.
The Bonds are in a trading range on this chart. (Bracketing market,
balancing area, congestion area and consolidation are all synonyms).
Three Guidelines for trades:
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Low volume stops activity.
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High volume represents value and is seen as an attractor
(the first time traded back down to only!)
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Don’t fade moves out of the middle!
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Holes in the distribution area provide excellent risk/reward
Cocoa – “long liquidation break” took care of a market that was
overly long inventory. This process makes a market stronger. Price
quickly retraced back into the previous day’s “hole”. Holes are even
more important when they show up over longer distribution periods.
Nat Gas: Look how the market came into perfect balance with a narrow range non
trending day. This is a classic formation that very often leads to a trend day. A trend day
shows a steady markup throughout the day, opening at one end of the range, closing at
the other with range expansion. This demonstrates strong conviction.
An example of a “failed auction”. Price drove higher out of an
established balance point (high volume node), but failed to attract
new buyers at higher prices. Minimal volume traded at the high
prices. The “single prints” demonstrate “price rejection”.
Coffee market:
Balance bars, and the market fills in holes.
Crude pushed out of a well developed value area. Will it attract volume at this higher price
level and establish value? Note the excellent risk/reward point. If price fails to hold the
short term support, it will fall back and retrace through the hole to previous value. If it
holds this markup, it can start to trend higher. The red lines indicate the attractors below.
in.
Corn also has an excellent risk/reward spot. If it does not hold the purple line it will fall
back down and develop the lower volume trading areas. This could be an excellent
support are to trade against to the long side as well.
Corn – follow up on 15 minute chart.
This is a volume distribution for the Eurocurrency with a ten day look
back period. It is right in the middle of value, perfect balance. This
is the worst possible area for initiating a new trade.
Market structure in IBM (May 1, 2012)
Condensed profile versus daily bar chart. Price closed at the top of
the established value area. (Now we are going to examine the
previous principles over a much greater time period).
Market structure in AAPL (May 1, 2012)
Condensed profile versus daily bar chart. Price is below the point of
control and at the lower end of the value area.
The same concepts can be applied to weekly and even monthly data.
This weekly chart of the QQQs needs further profile development in
order to form the classic bell shaped curve.
The weekly chart of the Dow, however, shows a beautifully
developed profile ready to support a further advance should the
“higher time frame players” choose to step in. 12950 is fair value.
Monthly Dollar Index: Longest line on the board….multi year “fair value”!