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Market Profile Trading - How is Market Profile used in Day Trading?

Updated: Dec 16, 2020

Market Profile is a technical concept with a unique charting technique developed by Peter Steidlmayer when trading at the Chicago Board of Trade (CBOT), and it was open to the public in 1985.

Market profile is a style of plotting "Price" on the Y-axis and "Time" on the X-axis, which most of the time form a bell-shaped image as the body of the profile.

It helps day traders identify Other Timeframe Participants (Big players) who have money and information power. Our job as short term traders is to follow these big sharks which give direction to markets.


Table of Contents


What is Market Profile Trading?


Market profile assists the short term traders to read the current market trends as it unfolds. It considers the latest market data as it comes and provides an excellent price, time, and volume analysis to give the best of the best information about what it wants to do next.

It provides an X-ray vision about the market as Value Area represents 2/3rd of the day’s activity (or 70% in some cases), and this will give a clear picture of the current state of the market as it unfolds.

It works in all the market conditions. Usually, a trading system or indicator works in certain market conditions like a trending or sideways market. There is no such restriction to Market Profile as it clearly shows the balanced and imbalanced market conditions in both directions all the time.


The marketplace is full of different players like big buyers, big sellers, scalpers, intraday traders, swing traders, and positional traders. The combined action of these players together is the main reason behind price fluctuations.


Big buyers and Big sellers will execute their plans at different price levels, and they cannot trade with each other at the same price level. Others act as a bridge between these two payers by providing liquidity, as shown in the below image.



Let's say a script is trading at 100. Big Buyers will have a plan to buy this script only below 50, and Big Sellers will have a plan to sell this script just above 150.


If we restrict the trading activity in this script only to big buyers and big sellers, the price will be stuck at 100 as both of them don't have plans to trade at this level.


If we allow other players such as scalpers, day traders, swing traders, etc. then they provide liquidity to the market. Their participation will take the price to either 150 or 50 depending on all other traders' combined effort except the big players. If the price reaches 50, big buyers will pitch in, and if the price goes to 150, big sellers will pitch in to initiate their trades.


This interaction between big players and short-term players distributes trading volume in a bell-shaped curve, as shown in image 2.


Bell Curve Concept in Market Profile

The primary purpose of any marketplace is to facilitate trades. A script's price will go up until the last buyer has bought, and there are no more buyers at a higher price, which is recognized as Unfair High.

Similarly, it moves down until the last seller has sold. There are no more sellers at a lower price, which is identified as Unfair Low.

The end of the upside auction is the beginning of the downside auction and vice-versa. Hence, we can say the marketplace facilitates trades with the "Dual Auction" process.

Once the market defines a range with an unfair high and an unfair low, it negotiates within the range to establish a "Value Area."


|Also Read - The Complete Guide to Intraday Trading



Market Profile Charts


It is effortless to plot a market profile chart using an excel sheet. First, let us understand how a #marketprofilesoftware plots the chart, then it is easy to construct in an excel sheet.


Each half an hour of the trading day is designated by a letter, which is also called Time Price Opportunity (TPO).


Market Profile chart in Nifty (Split Profile)

We denote the first 30 min range with the letter ‘A,’ next 30 min range with the letter ‘B,’ and we continue this procedure until the last range of the market.

The above chart is of Nifty, and hence the last range is denoted with ‘M’ as the Indian markets currently trade from 9.15 am to 3.30 pm with the last session ‘M” is for only 15 minutes from 3.15 pm to 3.30 pm.

O’ in the first session indicates the open price level, and ‘#’ in the last session indicates the closing price level.

This charting in Market Profile is called ‘Split’ profile, and pushing these TPOs (letters) on the left side (wherever space is present) will create the ‘Un-Split’ profile, as shown below.


Market Profile chart in Nifty (un-split profile)

Point of Control (POC) is the price level in which maximum time was spent (Price Profile) or maximum trading activity (Volume Profile) occurred on any day.

In the above image, 9980 is the point of control (POC). Value Area (VA) is the 70% price range around POC. It is the fair price of the Nifty on this particular day. So range from 9958 to 9992 is the Value Area (VA) on this day.

By the end of every trading day, the market profile chart shows not only what happened on that day, but also who is responsible and when it happened.

There is much software that can plot the market profile chart in the live market automatically. Traders can use any of this software or use Excel to write the MP chart manually.

To know how to plot the market profile chart on an excel sheet, watch this video.



Market Profile – An Indicator or Not?


Most of the technical indicators which are available in the stock market are derived using different types of calculations from the price - Open, Close, High, Low, and Volume.


All these indicators assist traders with Buy/Sell decisions either directly or indirectly.


For example, an RSI reading of 30 indicates an Oversold situation and advises the traders to look for a long trade.


Similarly, short-term MA (5 DMA) crossover above long-term MA (50 DMA) indicates the end of the downtrend and advice traders to plan a long trade.


Whereas, Market Profile assists the traders to read the current market trends as it unfolds. It provides a 3-Dimensional view as compared to the traditional 2D view in Candlesticks charts. The prominent feature of the market profile is it enforces the traders to study the market dynamics and don’t generate any buy or selling decisions.


Hence, Market Profile plays a different role as compared to any traditional indicators in the market.


Does a Market Profile Work in Intraday Trading?


If you think of all the big players as a single personality, it is possible to estimate their activity based on their conviction. Market Profile, with its unique features, identifies a few readable patterns in the daily time frame based on the level of participation of big players.


IB Range is the first one hour range in the market created by retail traders (most of the time).


Retail traders can only provide market depth and liquidity, but they fail to give magnitude and direction to the price.


Based on IB range and price variation around IB range, Market Profile identifies 6 important day structures:


1. Normal Day

2. Normal Variation Day

3. Trend Day

4. Double Distribution Day

5. Non-Trend Day

6. Neutral Day


On 100 trading days in any market (be it currency, commodity, or equity), over 75 days will be Normal Variation (NV) and Trend Day. NV day and Trend day are the trading days in which the price extends, breaking either low or high of the IB range.


So, if a trader just deploys a trading technique (like ORB Technique) to take advantage of this feature, he will be on the profitable side most of the time (75% ignoring whipsaws and self-mistakes).


Hence, there is no such thing as the market profile that does or does not work. It is only a trading concept that provides an extra edge for day traders and short term traders.


If you apply it properly, you make money, and if you don’t apply in the right way, then you lose money.


Market Profile Books


Below is a list of good books that are helpful to learn Market Profile in detail:


(Some are paid links)


Market Profile Software


Market Profile Software is helpful for committed intraday traders. There are many resources to get market profile software. However, BellTpo is one of the best software to view market profile charts.


If you are looking for free online market profile charts, then you can check with gocharting.com


Market Profile vs. Volume Profile


In a Market Profile (price profile chart), total TPO (letters) counts will be used to calculate the Value Area of the Day. Price profile is also referred to as TPO profile.


In Volume Profile, it is based on the turnover (Quantity X Price). POC determined through volume profile will be the same as the Volume-weighted average price (VWAP).


The three essential components of the auction process are:


1. Price—it advertises all the opportunities.

2. Time—it regulates all the opportunities.

3. Volume—it measures the success or failure of all the advertised opportunities.


Volume is essential as 80% of the trading volume is given by 20% of the big players. However, time also plays a crucial role because a price not accepted over time is a sign of rejection of that price level.


Image - Volume Profile

A few traders use only the price profile, and they ignore the volume profile, but some traders use only the volume profile.


As you know, Price, Time, and Volume are the three critical elements in trading. Market Profile gives importance to time traded at a particular price that is considered in price profile compared to volume profile, which considers volume traded at a specific price.



Market Profile Course


Do you want to learn more about Market Profile and how to use it in Intraday Trading?


Then you can try the Market Profile Intraday Trading course.



 

© 2020 by Indrazith Shantharaj.