The Many Benefits of Market Profile

04/30/2012 2:55 pm EST


Linda Raschke

President, LBRGroup, Inc.

Too many traders get hung up on short-term indicators, says Linda Raschke, who tells how to use market profile to get an effective broad overview and avoid common missteps.

My guest today is Linda Raschke. Linda, talk about market profile. What are the most valuable concepts?

I think it’s an excellent tool to lend conceptual framework to the market. I really feel that too many newer traders get hung up on five-minute bar charts and oscillators.

These things are valuable because they’re going to give you overall bias if there’s an upswing or a downswing, and so forth, but if you study market profile theory, that’s really the true basis of auction theory, which goes to the heart of the price discovery process.

Every different methodology has its own semantics or terminology, but market profile takes away the time element and consolidates the actions.

See related: Get More with Less Indicators

You can see the levels that the price traded most about, so you have a central value area, and several key concepts can come out of that. If you push away from a value area, then you can come to a stronger trending environment.

With traditional technical analysis, you would want to see volume confirm that. So you’re either pushing out away from one of those value areas, or, if the price hits an area where there’s price rejection—no volume—it’s probably going to gravitate back towards that central value area.

It’s a different feeling aside from the time concepts of moving away outside of a value area or retracing back into it.

Also, something that’s useful for people to think about are price-rejection spikes. When the market’s testing in the auction process—auctioning down, looking for buyers—you can have these price rejection spikes.

So if you’re keeping in the context that the market tested and rejected a certain area, perhaps you’re less likely to get caught up in buying that first retracement, thinking that there’s a bull flag on a five-minute chart.

It gives you a different way to visualize the price action, and I think that’s a great value to people.

Is this available on most software trading platforms?

It is, and I have to say the people that use it really latch onto it and identify with it. It’s not something that you have to use, but I just think that the concept that it lends to our field of technical analysis—or just study of the price behavior—is very important, because they’re free of that time denominator in the same way.

Just like point and figure charts, they’re going to give you a different type of representation of the overall price action. Point and figure is something that’s not used so much anymore, but the concepts have consolidated for a long time.

See related: How to Use Point and Figure Charts

There’s the old saying, the longer the base, the higher up into space, the broader the top, the greater the drop, and the point and figure charts are a way of indicating that. I just think it opens people’s minds up to a different type of conceptual framework, which is really important.

Then, when the day’s unfolding, there are some wonderful concepts. If people buy Jim Dalton’s book, Mind Over Markets, there are some good chapters that describe the price action around the opening. For example, when we’re talking about technical analysis, but yet the market gaps up and a whole different game plan could unfold, is there a strong drive off of the opening price?

This is free of bar charts and oscillators; now we’re looking at how does the price behave off of the opening? Is there an open drive, in which case it never trades below the opening price, but has a very strong initial 30-minute bar up?

If you see that, that is probably the presence of what we call the proverbial higher-time-frame players, and that can lead to a much stronger, trendier type of day. However, if you have open auction, which is open, rotate, fluctuate, on both sides of the opening price, if there’s light volume, the market’s probably going to stay in a relatively contained range all day.

As a trader, that’s going to set the tone that I might be more aggressive in making countertrend trades, which is really important. You don’t want to think about making countertrend trades on a trend day, and likewise, you don’t want to be trading continuation patterns if you’re just fluctuating in a light-volume range. I think it’s really important for putting things in context.

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