How to Use Market Profile to Find Great Trades

04/11/2013 12:00 pm EST


Market profile has become a hot topic again. Lots of traders are looking for information on how to use market condition profiles to find good trades. Our interviewee here has been a trader for over 25 years and settled on market profile long ago as the only statistically proven trading method. In fact, he thinks most day traders who use other methods are downright crazy. We talk about how he uses market profile and why it has been so successful for him.

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Tim Bourquin: Hello everybody and welcome back. Thanks, as always, for joining me for another conversation with a trader today. We're going to be speaking with Tom Alexander. He's got a ton of experience in terms of trading in the markets many, many years. We're going to talk to him about his approach to the markets and how he's kind of refined his trading process over the years to come to where he's at today. So, Tom, thanks very much for joining me on the phone today.

Tom Alexander: Hi, it's a pleasure.

Tim Bourquin: How would you describe yourself as a trader? What type of trader are you?

Tom Alexander: My trading has evolved. I've been trading for 25 years and all of that time I have traded in front of a screen, which sort of makes me a little bit unique. I may have more hours in front of a screen than anyone in the past 25 years. That's not necessarily a good thing, but that's the way it is. When I first started trading, you were really handicapped because the entire world went through the floor, and that's certainly not the case now. The floor is a much smaller piece of a much, much, much bigger puzzle than the trading world and that's been around for a couple of decades. I knew it to be back in the '80s or before.

Tim Bourquin: Well, that's interesting because I only asked you that because everybody hears that the floor traders have all the advantages, they're the ones who really know what's going on, so even back then did you feel like you were coming at it from a disadvantage?

Tom Alexander: Yeah. You definitely were coming at it from a disadvantage prior to electronic trading, but there's no question about it because the order flow went through. If you had size to do it, it had to go to the floor and it went through the floor before electronic markets and especially in the US, you didn't have any choice, you had to go through the floor. So they saw the dominant volume went through the floor. They knew who the players were and who was doing what and how much and where before anyone else knew. And when I first started trading, say the S&P, for example. You were lucky if you had what they call floor access. And floor access basically involved, you had the right to pick up the phone and call a phone clerk, and you had to trade five lots or greater most places to have floor access. Now, understand this is also a time when the S&P was $500 a handle.

Tim Bourquin: Right. This is before the E-mini, obviously.

Tom Alexander: Yeah. It was before the E-mini, it was before they split the big contract. Now, the volume that goes through the floor is really almost anonymous, and it's hardly ever a directional trade. It's almost always a piece of another trade that's going on, but I think the true edge has flipped from being on the floor to being off the floor and plus floor traders it's a completely different world. They're holding things for seconds; they have to have an edge. They can buy the bid and sell the offer all day long, which in itself is an edge. We can't do that off the floor. So off-floor trading is a completely different animal than trading on the floor. And I had to learn to adjust to that very early on. And as trading has evolved, it's really a sort of the revenge of the screen trader at this point in time if you have that experience having to trade in front a screen for this long, you're sort of ahead of the curve now, everybody's coming off the floor scrambling trying to figure out how to transition into a screen-based methodology.

NEXT PAGE: Why Most Traders Fail


Tim Bourquin: So, are you a pretty short-term trader?

Tom Alexander: Well, I trade all the time frames. I trade intraday, but even my intraday trading is not this frenetic in and out trade huge size in trying to make a few ticks. Most of the trading world, and I think this is the reason so many people fail to make it in trading, they're one-to-one traders. They are risking, and let's say if you're trading the S&P E-mini, they are risking six ticks to make four ticks. Well, the math doesn't work. And they're really trading price; they're price-based traders. Are there people that can do that? Yes. But they're far and few between and the shorter the time frame you trade, those people that are able to do it, are sort of under the category of savant. They have this unique ability that really can't be learned, it can't be taught, it just sort of has to be there.

Tim Bourquin: So, how do they get themselves into that position, what are they looking at where they're saying I'm risking six to make four?

Tom Alexander: Well, I think a lot of it is a vestige of the attitude of what the floor used to be, you've got all these guys. The industry is still heavily influenced out of Chicago in the old style of trading coming out of the pit, and those guys are frenetic traders. And so a lot of that, they had to come off the floor, and the only thing they know how to do is to scalp. And so they try to come up with all these games to scalp, and it's really not. I mean it's just a completely different type of trading and it just does not lend itself well in the big picture to having an edge over a period of time, even if you're an intraday trader trading in front of the screen, but it's a vestige of all floor activity really. Even if you're an intraday trader, I trade the same way in the short-term time frames that I do in the long-term time frame, which is a unique part of the methodology that I use to trade. I'm trading market condition. I'm not a price-based trader. I'm trading auction market principles. Most people understand that under the term of market profile.

Tim Bourquin: I've a heard a couple of people talk about in the last couple of months, maybe only one other interviewee, I think, talked about it and referred to it as the auction and that's really how they think of it.

Tom Alexander: Most people that say they're trading market profile are trading a graph. Market profile is just an artifact. It's a graph artifact of an auction market process, and if you're just trading the profile graph trying to turn points on that profile graph into magic, that's not going to work either. You have to understand how and why that graph looks the way it does, and then you get into the necessity of understanding the deeper constructs of auction market principles and how the market forms around these principles, and that's how the development and the structure of the market through the lens of this auction market principles. And if you understand that, you can look on the bar chart and see it, but it's a completely different, it's a paradigm shift in terms of viewing the market and analyzing the market and also trading the market. But it is uniquely robust because it applies in all time frames. I can use the exact same concept on a five-minute bar chart than I can on a five-day chart or a five-week chart or a five-month chart.

Tim Bourquin: And you're still trading mostly the S&P these days?

NEXT PAGE: How Does Market Profile Work?


Tom Alexander: I trade the S&P, but I also trade other contracts, and that's something else. If you think about it, if you want to call yourself a trader and you want to have a trading business, it's foolish to try to confine yourself to one market in one time frame because sometimes then you run into the tendency where people try to pound the square peg into a round hole. Sometimes your favorite market may not be particularly tradable; it may not offer the best opportunity. So, it makes much more sense to understand how markets work, and if you have something that is valid, then it should work across all markets.

Tim Bourquin: Give us an idea, then, like for instance this morning, when we're recording this it's Monday, people will be listening to this a few days from now and maybe a week or two from now, but I think it's still instructive. You get up this morning on a Monday morning, how does a market profile trader approach the day?

Tom Alexander: Ideally, what you're looking for is you're looking for a market that is imbalanced. There are two phases of market development: balance, which to most traders is a consolidation or imbalance, which to most traders is a trend. And the market is, to keep it simple, basically in one or the other of those two phases of development. Now, when a market is in a balanced phase of development, that's the only phase, only market phase in which you can determine objectively and consistently what value is. And so when you can determine what value is as a corollary, you can determine what it is not.

Tim Bourquin: So, what does it look like on the chart, I guess?

Tom Alexander: Well, it looks like a bell curve for lack of a better word, OK? You got the tails and you got the fat part, the middle. Now, sort of visualize that bell curve turned on its end where you have an extreme high and extreme low and then you have the fat part of the middle. And the extremes of that shape, the upper extreme and the lower extreme are unfair prices. And the fat part, the middle, the first standard deviation is the area of greatest value in that time frame of that particular auction. And as long as the market is in balance, price will be attracted, the price will be regressive back to value away from those extremes. And when you can identify this condition, then it helps you objectively identify the best reward to risk opportunities and it tells you where you should be trading, and it helps you to just sit there and wait for opportunity. Most traders overtrade, egregiously overtrade, especially intraday traders, they trade way too much. All opportunities are not equal all day long.

Tim Bourquin: Do you find that opportunities only comes a couple of times a day or they're plenty, but you're choosing from the right ones?

Tom Alexander: Well, I would say they're probably at most three or four good opportunities a day. My definition of a good opportunity is a reasonable opportunity to catch a substantial portion of the day's range. I'm not a scalper and most people that are scalpers, I mean it's just an incredibly difficult way to consistently make money, and it's a unique skill set that then doesn't apply itself to say going over and trading corn. I can trade corn the same way I trade the S&P futures. I can trade gold the same way I trade the S&P futures. I can trade the euro the same way I trade gold.

Tim Bourquin: Can you talk about a recent trade you've had that again just kind of gives us a good instructional base for the type of things you look for?

NEXT PAGE: How Tom Looks at the Markets


Tom Alexander: Let me think about that. Let me pull up some charts here and just go through some screens. Well, in terms of opportunity, like right now, I'm looking at a chart of corn, and corn has been in a balance area for about two months, and then right now the corn is perched in smaller degree area of balance in the extreme of the large degree balance area. Now, this trade hasn't been triggered yet, but the trade out of this area should be sharp. So, regardless, you could flip a coin and go short or you could flip a coin and go long, and in either case you have a defined amount of risk, and your potential, which is more difficult to determine, though, should be a multiple of the risk taken. So that's what you're looking for, you're trying to find these opportunities where a market is in the phase of development. You had an extreme and then you have a setup in that extreme that's basically a fractal of the larger degree of time that the setup really it applies to.

Tim Bourquin: I was going to ask you why is the risk defined, though, on either side?

Tom Alexander: Well, the risk is defined because if you're using a balance area, in a balance area you have a defined upper extreme and a defined lower extreme. And if I go short for instance, I know I'm wrong if the market takes out that upper extreme. If I go long, I know I'm wrong if the market takes out that lower extreme. But what is known in market profile parlance as an initiative trade, which is where you're going with the breakout, the breakout will, over time, be a multiple of the risk taken of the risk that is required to accept that trade.

Tim Bourquin: So, market profile has its own set of terms and definitions for the market. What made you settle on this as the way you wanted to trade?

Tom Alexander: Well, because 25 years ago, I was like every other trader, and I was looking at everything under the sun and all the magic and all the numerology that's involved in the market, and none of it had really any kind of statistical rigor behind it. And I first became familiar with market profile, which is the brainchild of an ex-floor trader named Peter Steidlmayer. Steidlmayer was on the floor for years and he visualizes the concept of how the market develops and basically that bell-shaped type of thing when he was on the floor. And it was very, very popular in the middle to late '80s. As it turned out, nobody could really trade it the way Steidlmayer was articulating the concept. But through the years, I continued to search and to study market profile because it was very, very different than most of your price-based stuff out there, all the oscillators and Fib stuff and Elliott wave and Gann, and all the magic that everybody seems to gravitate to. Long story short, there is a guy named Don Jones. His website is Don is actually a scientist, he's a physicist, and I came across Don's work and he has done some incredibly profound research that furthered Steidlmayer's qualitative ideas and quantified, improved an edge. And that's what I continued to trade and research myself to this day, as Don does. Don and I became friends and it's very unique especially in the retail domain that there is something with some semblance of rigor behind it because to my knowledge there's nothing else out there in the retail domain that has any rigor behind it whatsoever.

Tim Bourquin: Now, you mentioned that you hadn't traded a lot in December. Is that because volatility is lower, and how does that affect market profile?

NEXT PAGE: Tom’s Methodology


Tom Alexander: Well, when you're talking about market profile, again, market profile is just graph. It's an artifact of an auction process and that process is in effect, in all degrees, at all times, so it was in effect in December. I just take time off in December because your volume drops off and there's more randomness in the market in that time period than any other time, that doesn't mean there aren't good moves, but I'm sort of over thinking I have to come in to the office and trade eight hours a day everyday, 52 weeks out of the year, it's just a great time to take off.

Tim Bourquin: And I want to go back to the part where you said, you're looking to get or capture the majority of the day's move. Does that necessarily mean that you are initiating most of your trades in the first 30 minutes hour?

Tom Alexander: Well, the first 30 to 60 minutes of trading in the S&P or the stock index futures offer the ideal opportunities. Now, catching the ideal doesn't happen, once a week maybe, but when it does you can make your week in one day. My ideal trade is getting a trade on in the first hour of day, then just let it sit all day long. But to be able to do that, you've got to understand why you think you may be catching the high or the low of the day and there are good reasons. There are statistically sound reasons in ways to look for that trade in that first hour. We're talking on a Monday. Well, there really was not a great trade in that first hour of the day just because of the nature of the way the market traded in that first hour, so it wasn't there today.

Tim Bourquin: Now, what are those most things? You mentioned that, statistically, ways you can see whether you're catching that top or bottom, can you talk about that?

Tom Alexander: Well, statistically, in the stock index futures, about 65% of the time, you know the high or the low of the day. The high or the low of the day is put in the first 60 minutes of trading. So, if something happens in the first 60 minutes, and there are other little statistical factoids like that, that you sort of try to line up, and when you line these things up and you're using the key reference areas, I call the areas that are formed in this auction market process key reference areas. When you line up a situation where price is hitting a key reference area, and let's say that happens to be within that first 60 minutes of trading, then you've got a great trade.

Tim Bourquin: You also mentioned the initiative trade, is that your favorite one? Do you like those breakouts?

Tom Alexander: Not necessarily, it depends on the situation. An initiative trade is just basically a trade where you're going with the trend expecting a breakout off a balance area. It’s still viable to take what is known as a responsive trade, which would be the flip side of that trade. You don't think the breakout is real, so you fade it. So a responsive trade in market profile parlance is a fade, and an initiative trade is the trade that you're taking, expecting a breakout and catching a trend.

Tim Bourquin: The charts for market profile, is this available in most platforms today, or is this something special you have to use?

Tom Alexander: No, they're available in most platforms. Now, you usually have to pay extra to have access to a market profile charting format, but market profile seems to be catching on and becoming more and more popular, so most software packages offer a market profile charting package.

NEXT PAGE: Setting Trading Goals


Tim Bourquin: Was there a book or something that you read early on that helped you get a good grasp on this, so we can maybe recommend?

Tom Alexander: Well, I've read a whole of Steidlmayer's books. The best book out there is Donald Jones' book, Value-Based Power Trading. It's sort of a hokey title, but it is probably the most rigorous book on trading out there.

Tim Bourquin: Let's talk about your trading goals or how you're personally judging success for yourself. When you're trading for a living, what is it for you that says, "I've had a good year." And did you have a good year last year and how did you judge that?

Tom Alexander: Well, yeah, yeah. I had a good year last year. Consistency. If I'm consistent and I follow my rules, I'm going to have a good year. I've been trading for 25 years, so all traders have drawdowns; that's inevitable. You can't avoid it that's just a mathematical certainty. But you also know if you have a legitimate edge that as long as that edge is there you're going to have a positive return over a statistically balanced sample of trades. And from there, it's just the amount of leverage that you want to use. And leverage is something that has to be respected because the more leverage you use, the closer you get to a risk of ruin, regardless of the amount of edge you have, you can have a huge edge, of let's say 65%, which would almost be unheard of, quite frankly. Even if you have a huge edge, if you over leverage it, it's not a matter of if you're going to blow up, it's when you're going to blow up. So I am much, much less aggressive with sizing than I used to be because I don't need to expose myself to blowing up.

Tim Bourquin: And do you have a certain percentage that you watch in terms of how many trades are winners versus losers?

Tom Alexander: No, I really don't. My percentage of winners tends to get better every year, but it's really not and that's something else that most traders make the mistake. They think they have to be right 60% or 70% of the time, you don't. You don't even have to be right 50% of the time and that's focusing on the wrong thing. What you want to be focusing on is your average winner versus your average loser. And as long as you want to develop a trading system or you have margin of error where you can be wrong two out of three times and still make money. And that's why all this price-based trading that intraday traders do is so mathematically flawed. In the long run, it's almost unsustainable to try and trade, try to risk four ticks to make four ticks or even worse, risk six ticks to make four ticks. I mean there are schemes out there on the Internet where guys are risking eight ticks to make four ticks. I mean this is stuff that's right there on the Internet.

Tim Bourquin: So, when you say priced-based, even to a certain extent market profile, when you talk about balance, is based on price as well?

Tom Alexander: Well, not really. It's based on market condition. You're really judging a much more macro view of the market. You're identifying a market condition and you stay in a trade until that condition, until your trade is invalidated by something happening, as opposed to price. For instance, most day traders say "I'm never going to risk more than two handles, two points in the S&P E-mini." Well, that’s dumb. How can you say that? You can’t impose an artificial constraint on a market that is dynamic. I mean the volatility waxes and wanes. I mean two points this past December is a completely different situation than two points the December prior to that. So you've got to learn to judge the market from a different view than just price-based trading.

NEXT PAGE: How Do You Measure Success?


Tim Bourquin: Does it take into account or do you watch news as a factor of whether or not you're going to trade.

Tom Alexander: Well, I'm aware of the news. I mean, in this day and age, you've got to be aware of the major announcements like Fed meetings and things like that, but I'm not somebody that fixates over every single announcement every day.

Tim Bourquin: And how about equities? Would market profile work just as well with equities?

Tom Alexander: Absolutely.

Tim Bourquin: And you favored the E-mini S&P why?

Tom Alexander: Liquidity.

Tim Bourquin: OK. You said three to four opportunities everyday, how many trades a week are you typically trying to finish out and are you trading on the weekend?

Tom Alexander: If I take ten trades in a week, that's a lot for me. I don't trade everyday. You can be an intraday trader and not trade everyday, and that's something else most people don't understand. The most important thing you can do as a trader, most of the time, what you really should be doing as a trader is nothing.

Tim Bourquin: I've heard that and does that mean that you aren't necessarily watching the markets all day though and kind of just sitting on your hands or you're walking away.

Tom Alexander: Yeah. Well, sometimes I'm not. If I do my homework and the market is clearly not likely to be in a position the next day for an opportunity, then I don't pay any attention to that particular market. I'm increasingly interested in looking for opportunity across a portfolio of markets as opposed to being fixated on the next three and half minutes in the S&P E-mini.

Tim Bourquin: It probably suits your personality, I would imagine.

Tom Alexander: Well, if you look at this as a business, this is not a game. It's a very serious business, and I'm just trying to find opportunities to make money in my business.

Tim Bourquin: And when we talk about goals we didn't talk about actually the pure dollars, I mean do you set yourself a goal in terms of dollars?

Tom Alexander: No. I just try to be a good steward of whatever money I'm trading at that point in time.

Tim Bourquin: All right. Let me push you just a little bit on that because I like to push back a little and find out. We're in this business, you've acknowledged it's a business and we're in business to make money, how do you know if you're doing well if you're not judging yourself on those dollars to some extent?

Tom Alexander: Well, you know what a good return is. To me, a good return is 20% to 30% on your money. If you can make 20% to 30% on your money consistently, you are an all-star of epic proportions.

Tim Bourquin: It's just batting over 300, it's those guys, the same thing, a baseball type of analogy, I guess.

Tom Alexander: So, if you can make 20% on your money year in and year out, you could write your own ticket doing anything you want to do. And it's the people that over leverage that try to take a $25,000 account and say, "Well, I have to make $150,000 to live to try to take $25,000 account make $150,000," they're going blow up.

Tim Bourquin: That was my next question, was how much should you start to do market profile successfully.

NEXT PAGE: What It Takes to Master Trading


Tom Alexander: Well, again that all depends. Everybody has a different set of circumstances. If you need $100,000 to live, you can back into the numbers. In trading, you've got to learn to trade before you can make money trading. Most people get into trading thinking or saying, "OK. I've got to make money." Well, it doesn't work that way. And what you got to do first is learn how trade. You can't just sashay into this and say, "Well, my needs are a buck and a quarter a year. I got to make $125,000." Well, it is not going to happen if you don't know how to trade, you're going to lose all your money.

Tim Bourquin: Can you do it while you learn? Can you make money while you learn?

Tom Alexander: I think most people should have an expectation of treading water while they learn, that would be an excellent result.

Tim Bourquin: And how about paper trading, did you do that before you started?

Tom Alexander: I'm not a big fan of paper trading. I think people should start off as quickly as they can with the real skin in the game, but trading very, very, very small size.

Tim Bourquin: And would that be the E-mini or some other contract on a smaller basis?

Tom Alexander: Yeah. And you could use the equity ETFs, you can use the proxies for the S&P E-mini, you could trade the Spyder or a fraction of the Spyder, or you could trade the SSO, which is a 2-beta S&P to the outside, or the FDS, which is the 2-beta proxy to the downside or fractions of those. Most newer traders have their own perspective, they come in to the business expecting to make money out of the box and that's absurd. I mean, it flies in the face of any other business.

Tim Bourquin: Right. Nobody expects to do any profession typically without going to school first and learning that and learning how it works.

Tom Alexander: But even after you've gone to school, you typically serve an internship or an apprenticeship before you become anything resembling confident, much less expert in whatever field it is, whether it's law or medicine or a car mechanic.

Tim Bourquin: All right. We'll finish up with this. I have to ask you about the weather because we hear it about it on the news everyday and it sounds like you follow some of the ags a little bit. How is that playing into your trading these days?

Tom Alexander: I haven't paid any attention to it whatsoever. I'm just interested in how the market reacts to things. The market determines value, that's one of the unique things about this, it's completely internal, it's completely objective, and consistent in determining what value is. Its value is determined by the actions of the buyer and the seller themselves. What they're doing and where they're doing it and how much they're doing it. And I can see that through this auction process.

Tim Bourquin: It's all built-in. It's built into the market profile chart.

Tom Alexander: Well, it's built in the auction market process, yes.

Tim Bourquin: Tom, thanks very much for joining me today and sharing some of this information about market profile. It’s a subject we’ve gotten a lot of questions about lately, so I appreciate you sharing your thoughts.

Tom Alexander: Tim, thanks a lot, I appreciate it, sir.

Tom Alexander can be found at He is also a contributor to

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