The Market Profile is a very popular tool in futures trading, and rightfully so, it’s very powerful because it can give us an understanding of where markets are balanced and imbalanced.
Why is that important? Because this is how we can identify where large market participants are active and expected to create large moves.
You’ve probably seen generally what the market profile is all about, however, we’re not going to bore you with the basics, just a few of them.
I’ll break down what one of the most important pieces of the market profile actually is, the Initial Balance and how to use it effectively. All the while comparing it to other similar tools.
By the end of this article, you’ll have a few A+ setups and strategies just using the initial balance that you can implement right away.
General breakdown of the Market Profile
First, we need some groundwork done with the market profile before diving into the complexities.
The market profile allows you to identify the relationship between price, volume, and time in the futures market.
Which in turn allows traders to break down the structure of the market, the price distribution and what has been going on over periods.
It was developed by J. Peter Steidlemayer in the 1980s to allow traders to get a better insight on the structure of the market, specifically in terms of balanced and imbalanced areas. Where markets make excess and where they create balance.
Usually called a time price opportunity chart, it does just that.
It’s broken down into periods, with each period being 30-minutes of time, each period has a corresponding letter associated with it. A will be 9:30 to 10:00 am EST, B is 10:00 to 10:30 am EST, and so on until the day ends.
The market profile develops similar to a volume profile, where you have the value area, balance, and point of control.
However, it can also show you where there are failed auctions, excess moves, single prints, and more aspects like that, which are useful for us to understand how the market is shaping up, direction, and continuation potential.
Not to mention one of the main tools that I use, the initial balance.
The image below represents the market profile for an individual session, you can see there are two market profiles.
The one most left is the split-up profile in each 30-minute interval, the one directly to the right is what it looks like compressed.
Attached to the market profile is a volume profile immediately to the right of the second market profile.
Here are some of the things you should know about the market profile before we go into the initial balance:
| 1. Time price opportunity periods | These are the letter periods from A to O on a day to day basis, each of these is a 30-minute period that allows us to see where the auction was traded in price throughout that 30-minute period. |
| 2. Value area | The value area is the region where 70% of the volume on the session trades. This is like a normal distribution that allows us to see balance and value for that session. Markets tend to want to stay within the balance. When prices move outside of balance, the idea is there should be an expansion to continue in that direction. |
| 3. Point of control | This is the single area that has the most volume throughout that session that is outlined by a different coloured line, in this case purple (my chartbooks). At the POC, since the most volume is accumulated, price tends to gravitate towards that area and hold rotations, making it a solid target but not ideal to trade from. |
| 4. Fair Value | Fair value can also be used as the value area, however from a normal distribution perspective, fair value is the area where we have balance. So that means in a given day, we can have multiple balanced areas that are not the value area. It’s seen as the regions that have multiple high volume nodes stacked together. |
| 5. Excess moves | Excess moves are individual periods that extend by themselves away from the other multi period levels and balance. |
| 6. Single Prints | Single prints are regions that are passed through quickly that leave behind an imbalance to show strength in buying and selling that can be used as support & resistance structures. |
| 7. Poor Highs and Poor Lows | Poor highs and lows are areas of failed auctions or incomplete auctions where 2 or more periods trades equally without excess. They create turning points in the market. |
Introduction to the Initial Balance
The only thing we didn’t talk about in the table above is the initial balance, the star of the show today.
The initial balance is the first hour of the trading session. Meaning A & B periods together.
All of the price points where A & B period trade, the high and the low are going to create the IB high and low, this allows us to find the first hour’s balance on the day, and from there we can get a better understanding of the movement of the day.
The initial balance is the guideline that will allow us to get a read on the day, whether it’s going to be a trend day or we can just play the range that is the initial balance.
In short, it allows us to see what the direction and strength of the market actually is.
How to effectively use the initial balance?
The question is, what can we do with the initial balance, and how to use it effectively?
The initial balance is to be used to understand if the session is expected to be set up as a range, wide or tight or we can get some kind of trend out of it.
If we consider the first hour of the session the overall range to hold or break, we can wait until 10:30 am EST to get that data and trade after that. This allows traders to get more confirmation of the direction of the session. Meaning more information to make an informed higher probability decision on how to trade.
Using the initial balance alone can be effective, but also if we use it in relation to auction theory and where we have large distribution extremes, the strength of the IB becomes that much larger.
Meaning, if we have key large auctions based on a 200-day cumulative volume profile, we can see where the extremes of that are and where the balance is in relation to the IB.
If we are in a large balance and the IB high and low respect that large balance and its extremes, we have that much more confirmation.
For example, in the image below we have the initial balance low that comes into confluence with the large (right) cumulative volume profile balance low. This area is a huge support structure for price.
If we can expand under both, you have the large expectation of a large move to the downside.
There are two rules to the Initial balance and trades around it.
Should we make a move outside of the IB, high or low, an excess move on a period after the IB, meaning C period and beyond, we want to see if that period closes outside of the IB or we just make an excess move just to close back within the IB.
This by itself speaks to the strength and potential direction of the market.
- Should we get an excess move outside of the IB and we close that period well outside of the IB, the expected move is to continue the directional trend of that excess move.
- Should we get an excess move outside the IB and that period fails to close outside. This means we close the period back within the IB, we can look for a trend move to trade into the other side of the IB.
There is a 70-75% probability that these situations play out.
If we close outside of the IB on a period, there is a 70-75% chance we see the continuation in that direction.
Likewise, if we fail, we have a 70-75% chance we will go to trade the other side of that IB failure.
A few A+ set-ups using the initial balance
It might be obvious at this point what the setups look like based on the information above.
They revolve around the idea of excess moves around the IB and closing around the IB. We can add the idea of where large balances actually stand to add to confirmation for that move.
The first is the failure to close an excess move through the IB.
If we should see an excess move outside of the IB on a period from C and beyond, and that excess move fails to close outside of the IB, we are looking to either buy around the IB low or sell above the IB high for the expected move towards the other side of the IB.
Take a look at the example below.
We’ve seen this a lot throughout the article. We have the major distribution low at 5742, and the IB low at 5740 on the S&P500 futures, very similar levels. We see that D period makes an excess move below towards 5733 and failed, we close back within, meaning I can look to start buying 5740 area on the ES futures with the expectation of a move towards and into the upper band of the IB.
In this case, we move about 45 points from that low which is a great move, $2,250 per contract.
This setup works on the other side as well if we fail the top of the excess move of the IB high.
The second A+ setup using the IB is the excess move that actually closes outside of the IB.
In this case, we’re looking at a situation where the IB is created above a large balance on the 200-day profile, when we break under that area and close E period, you can see that there are a few tests in H and J period to sell into the 5805 area which is the IB low and the auction high.
When prices accept a large balance starting from above and selling into a large balance, that means the sell side should hold out, and you can sell rallies into that area.
This is a double confirmation of the sell that we can look for, and that is the trend. There is a 70-75% chance we see the trend continuation under the IB low, which then moves into the 5780 area, that’s 25 points on the ES futures, or $1,250 a contract.
Final thoughts
These two set ups that are based on the initial balance excess moves and the closes around those initial balance lows or highs are really high probability in trading futures. You may have to wait over 2 hours for that to set up in some cases, but it really allows traders to identify the direction and movement throughout the day.
You can watch a video of a full explanation on how this is done:
