Introducing Market Profile®
Market Profile®, also referred to as Steidlmayer, is a method of technical analysis which graphically represents time and price information through letter sequences and patterns. It can be applied to any market from stocks to commodities, and I find it a useful tool to help determine support and resistance, entry and exit points, and where to place stops.
Independent trader Peter Steidlmayer developed this method of technical analysis with the Chicago Board of Trade, and it first became popular with CBOT traders in the Treasury bond pit. Market Profile displays price on the vertical axis, and time on the horizontal axis. Letters are used to symbolize time brackets.
The bond traders liked this method so much, they began to track the timeframes by hand. They would manually write the letters of each time frame on trading cards or pieces of paper and tape them together to get the Market Profile history. Of course, today we have computers to do the work for us, and this method is used by traders off the floor and in many different markets.
Market Profile is an analytical decision support tool for traders—not a trading system.What it can do is reveal pricing patterns from any market as they develop. By effectively organizing price and time information, it is possible for traders to see which price areas the market is accepting, and which ones it is rejecting. You can use this information to adjust your trading style accordingly.
A Market Profile chart is comprised of letters that represent half-hour time frames. So, you might want to think of them like a 30-minute chart. When you look at a 30-minute bar chart, you’ll get the high/low in each 30-minute time frame. Market Profile displays each 30-minute time frame with letters, called time-price opportunities or TPO. Capital or small letters are used depending on the trading session timeframe--either evening or daytime.
A price level that has been confirmed over time takes on added meaning, while a price that is touched only briefly is just a price, and little more. Confirmed by time, a price can reveal market value.
A Bond Chart Market Profile
Now let’s look at a Market Profile chart for the Treasury bond market, illustrated below. When trading in the bond market opens at 6 p.m. CT for the evening session, the letter “W” will print at the price where the market trades until 6:30 p.m., the next half hour timeframe. Then the letter “X” will represent the high and low for the next half hour, until 7 p.m. This pattern is repeated throughout the session with progressive letters in the alphabet.
Time-price opportunities seek price acceptance though time and volume to create value areas. Prices will tend to gravitate towards certain levels for certain periods of time. These price levels have the highest amount of volume. The visual portion of the value area takes shape in the form of a bell curve. So when you see the bell curve, you’re seeing a value area you want to pay attention to.
The point of control, or equilibrium, is achieved when the TPO count is somewhat balanced. This price level is likely to be revisited in the future.
Looking at price action in the Treasury bond market on May 4, 2006, as an example, we see a perfect bell curve. The value area is within a small range between 106-06 and 105-29. The point of control is the longest line, where the TPO count would be balanced. The value area is 105-29 to about 106-06. You can use these value areas in a number of ways.
Applying Market Profile to Trading Strategies
So what can you do with this information? Market Profile is a tool that can assist you in developing support and resistance levels. You can also use it to formulate entry and exit points, and where to place your stops. The market action from the chart above on May 4 shows an almost perfect bell curve, as mentioned, with 106-02 as our point of control. On a day like this, the point of control is where the market is likely to snap back from this price. The market creates value at about 106-02, so if you were thinking about a day-trade later that day, you’d use this information to place a trade at 105-30, and a sell order at 106-04 up to 106-06. These are also support and resistance areas from the prior day. You do this given the theory that the market will snap back at your point of control, at 106- 02.
Let’s go back to May 2, 2006. We had a double-distribution that day, with a bell curve from 107-02 to 106-27 and a bell curve from 106-09 to 106-02. I like to use Market Profile to view double-bottoms and double-tops, so let’s look at this day as an example. We had a double bottom, represented by two letters on the chart at 106-02 (KM) and a double top, represented by two letters on the chart at 107-04 (st). I like to look for double tops or bottoms on Market Profile when day-trading, because the market will eventually tend to trade through these levels. Market Profile doesn’t tell you when it will happen, but you may be able use these levels as targets, or entry points, depending on whether you are bullish or bearish. It will tend to move through these levels by at least one tick.
If the market displays a triple- or quadruple-bottom or more, the market should push through those levels even more violently, the thicker the letters are at the end of the range. In this example from May 2, if the market is somewhat range-bound, for a day-trade the following day, you use the levels from the double bottom at 106-02 and double-top at 107-04. The next trading day when the market opens at 6 p.m., you could put in a buy order at 106-02, and place a stop five-seven ticks away, based on the market going through your level by at least one tick. Ideally if you’d gotten in at 106-02 and gotten out at 106-14, you’d have a gain of 12 ticks. Our point to go short, at 107-04, wouldn’t have gotten triggered, as the market never traded up to that level. So, we’d have canceled that order and moved on.
I’ve outlined some day-trading examples you can use with Market Profile. If you are expecting a relatively quiet day, you can look at the first few time frames from the current day in relation to value areas from the prior day. Use the prior day’s value areas to gauge short-term support and resistance.
If you are using trailing stops for intermediate- to long-term trades, you can check where value has been built during previous sessions to determine your stops. Maybe you’re a position trader and have been short a week or so, and you can see congestion areas building. If you are short, you might keep your buy stop at 106-19, just looking at prior value areas.
Again, the double top is visually represented by two letters at the end of the day’s trading range, and you can use that as an entry point the following day you are trading. If you are a long-term bond bear and the market trades up to 107-04, that’s where I’d be looking to short this market.
Market Profile can be used as a lagging indicator when you trade, and you may use it in conjunction with other technical analysis tools, such as moving averages or RSI, to help you confirm signals. When the market first opens, I recommend you let it set up a “pioneer range.” It’s best to let the market trade for three time frames, then gauge where it’s at before making any decisions. Keep in mind, support and resistance levels are tough to get through, but if the market does trade through them, simply go further back in time on your chart to find new levels to use.