Market Auction or How to Form a Correct Understanding of the Market Structure
After reading this article attentive the reader will understand when to buy a minimum and sell a maximum, and when - to buy a maximum and sell a minimum. Today we will talk about the phases of the market and the concept of a market auction.
There is an opinion that exchange trading is an auction where buyers and sellers work according to certain rules. This opinion proceeds from the theory of games, is based on numerous and rather complex formulas and is accepted ad factum in the investment community. As things really are, let's figure it out!
Before you continue reading, it is recommended that you familiarize yourself with the previous materials on the topic:
And what are we worse?
The fact that auction theory is a dark forest for us. Even worse - behind the trees (quotes) we do not see the forest (auction).
A task this article - turn trees in your mind into a forest, i.e. I want you to first learn to see the auction (or rather, its phase), then the current position of the quotation in this auction, and only after that you begin preparatory measures for opening the deal. This is ideal.
But even if your goal at forex is to get adrenaline, like in a casino (red-black, Buy-Sell), then understanding the auction phase will increase the chances of earning a big jackpot or help not to drain the deposit in one go, which is also important, since delaying The draining process increases the chances of breaking a big jackpot.
Therefore, the knowledge that you gain while reading this article is worth its weight in gold. And if knowledge is worth its weight in gold, then the examples will only be on the GC tool (COMEX gold futures).
I will operate with stock data on trading volumes. About where to steal free to take volumetric quotes in the Ninja Trader terminal - it is written here. Paid indicators for Metatrader 4 are described in this article. If you do not have the opportunity (I do not want to believe in it) or the desire (which is also strange) to buy volume quotes, then the market profile indicator, built on the basis of a tick chart, will always be useful. This is not quite an exchange volume, but for the analysis of daily timeframes it will more or less fit.
I will use the SBProX terminal. Despite the fact that I trade in MT, this terminal allows you to analyze what regular MT4 does not allow. I’ll talk about how to configure the terminal in the next article on this topic, in which I will show how to work with vertical and horizontal volumes in different phases of the market. The purpose of this material is to explain the structure of the market and the general principles of its functioning.
Auction Theory - The Basis for Understanding Market Processes
The story of the balance of supply and demand, we all taught back in school. So, this is the initial axiom. Transactions are concluded only when there are two parties: buyers and sellers. And both sides prefer to work at comfortable prices. Therefore, a normal auction has the form of a Gaussian distribution, i.e. view of a bell-shaped curve (Fig. 1).
Fig. 1. Gauss curve.
And now a little magic. We expand the picture in a vertical plane, add data on the number of transactions and get the usual exchange profile. This is a weekly cluster chart of gold (Fig. 2). I think everyone will see that there is much in common between the Gaussian curve and the liquidity distribution. Some clusters (highlighted by blue rectangles) are almost 100% identical. Others are different, but in almost every weekly cluster, zones of normal distribution can be distinguished, i.e. balance zone, where the bulk of transactions takes place.
Fig. 2. Examples of the classic normal distribution on a weekly gold cluster chart.
The normal distribution implies that 68% of the data (transactions, in our case) are between the middle, i.e. the most common data, and +/- 1 standard deviation. And 95% of the data (transactions) are in the zone +/- 2 standard deviations from the middle (Fig. 3).
Fig. 3. Normal data distribution.
Returning to the gold chart (Fig. 2), we see that the largest number of transactions takes place precisely in the region between -2 and +2 deviations in those clusters where there is full agreement with the theoretical distribution.
In other words, an auction of a certain period is formed from the average (DEW, control point, most traded price) and deviations from the average. When we see such a profile on higher timeframes, on younger ones we see a flat, i.e. balance.
The concept of balance is one of the main ones in the theory of auction. In the framework of the balance (if we take it wider, then the cost zone, i.e. 95% liquidity), the price goes from the most expensive purchase to the cheapest sale. Yes Yes. Exactly.
Cost falls until the moment when those who want to sell run out, and grows until the moment when those who want to sell run out. This is the main law of the auction.
Based on this, it becomes clear why, in the balance sheet, delta sales * are collected at the bottom of the range, and purchases at the top. This is a general principle. If there are no sellers somewhere on the bottom, then the buyer starts looking for a seller at higher prices. Indeed, as we recall, any transaction has two sides, i.e. without one of the parties there will be no transactions. If, however, a seller appears somewhere at the bottom and there is no buyer, the sellers push the bottom and an imbalance (impulse) begins, i.e. search for a buyer in the form of an avalanche collapse of the asset value. And the opposite situation: if there are people who want to buy at the top of the balance sheet, but no more people who want to sell, then there is an explosive increase in the asset value, i.e. impulse (imbalance).
* Delta is the difference between buyers and sellers. There are two ways to determine the initiator of a transaction. The first method is the most correct, because the exchange simply gives out that one transaction was initiated by the buyer and the other by the seller. Chicago Mercantile Exchange (CME) provides data on the initiators of the transaction. But the New York Stock Exchange (NYSE) does not provide such data, so the delta is considered in the direction of the teak. Remember that purchases are more expensive and sales are cheaper by auction. So tick up - delta in buy, tick down - delta in sell. Everything is simple.
Here is a one-hour delta chart of gold with a volume profile on Friday June 7, 2019 (Figure 4) after the release of the failed Nonfarm payrolls. I basically singled out only the balance after the impulse on the small timeframe. Price profile and delta price chart. It is clearly seen that at the lower boundary of the new zone of the value of the day (1344.6-1350.2 at Globex), which we determine by the distribution of liquidity, which is similar to normal and includes about 90% of liquidity, there are more sellers (we don’t care, sellers are or fixes / stops of buyers). In the low of each cluster, the advantage of sellers. And the same is at the top of the balance sheet - there are more buyers.
Fig. 4. Law of the auction: the market goes from the most expensive purchase to the cheapest sale on the example of the H1 delta chart Gc 06/06/2019. Delta in buy - positive values of blue; delta in sell - negative red values.
Figure 5 is absolutely identical to Figure 4, only instead of the volume profile I turned on the delta profile, and instead of the cluster delta chart I turned on the cluster volume chart. Everything is similar: the overall balance profile shows the accumulation of shorts at the bottom, and purchases at the top. But remember the self-similarity of the market, i.e. its fractality.
Fig. 5. Law of the auction: the market goes from the most expensive purchase to the cheapest sale on the example of the H1 delta chart Gc 7/06/2019.
We dealt with expensive purchases and cheap sales in the balance sheet, but what to do with the fact that in fig. 4 aggressive purchase is clearly visible (1344), and expressed sellers - in the range of 1349.2-1350.2? And in fig. 5 in the delta profile, these comrades also left a mark, violating the harmony of the distribution of sellers below and buyers above.
In fact, everything is very simple. Here is the M5 chart of the same fragment, where it can be seen that the purchase is at the top of the microbalance, and the sale is at the bottom (Fig. 6). Thus, the principle is observed. We just must not forget about the self-similarity of the market in different TFs.
Fig. 6. Law of the auction. Gc M5. Delta schedule.
And now the tricky question: you often sold at the bottom and bought at the very top, i.e. tried to work on a breakdown? I know that often, very often. And all because they did not know the auction structure of the market and fell on the continuation of the balance, while they wanted momentum.
Many of these transactions, you somehow displayed in 0 if you were trading without a stop and were waiting for a return. Sometimes, after you had smoked three packs of cigarettes, drank all the coffee, smashed the keyboard and sent the people around you away, the price went where it should, i.e. passed into momentum. But there were also deals when you were selling high / buying low (as it seemed to you), but there was no return. And deposits burned like poplar fluff. That is very fast. And neither coffee nor cigarettes helped to wait for a return: blood dollars melted through the gray smoke on the screen, and then came a margin call. Because they did not know the auction structure of the market and fell into imbalance (Fig. 7).
Fig. 7. The emotional state of the trader after the margin call.
Upset? Reminded of unpleasant moments? Then move on to the next section. But before that answer the questions:
- What is an auction and what is its main law?
- Why balance strategies work well in balance?
Have you answered? Then we went further, because the most important thing begins.
I think you already understood that balance is trading in flat, and you want an imbalance when the distribution becomes abnormal and it shifts in some direction.
I’m sure that you already feel that the market can be divided into two parts: balance (flat) and imbalance (momentum, trend). The story clearly shows how one goes into another. But how to find the transitions? To do this, it is necessary to complicate the scheme, which we will do now. But before that one more time about balance.
In any phase of the market, you can highlight the balance or momentum on the lower timeframe. Even if the cost changes very quickly, and right now it is the most aggressive part of the impulse (as the wave operators would say: “third wave in the third wave”), then on the second chart you can highlight the balance for 10-15 seconds. Balance is the most traded part of the market profile. Therefore, the analysis of quotes must begin with the older TFs and go down to the younger ones. And analysis is necessary in order to make a decision about entering (or not entering) into a transaction, as well as about its potential. Understanding that the balance is on the daily chart and the imbalance begins on the hourly chart within the daily balance helps a lot in trading from the borders. Now let's go.
The market is an auction that has a 4-phase structure: momentum - fix (response, climax) - balance - momentum (scrapping or continuation of the previous trend) (Fig. 8).
Fig. 8. 4-phase structure of a market auction.
Remember this. Impulse - fix (response) - balance - impulse. And again: momentum - fix - balance - momentum. Enough? I don’t think so. But if you repeat it as a mantra, then literally in a couple of weeks everything will fall into place, and the world (i.e. the market) will no longer be the same.
Market Phase Algorithm
The concept I describe means that the starting and ending points of the calculation are momentum. Therefore, to analyze the current activity, we find the last impulse on the higher timeframe. Usually this is a daily TF. To fully understand the phases of a market auction, you need to be able to analyze vertical and horizontal accumulations of volumes, i.e. analysis of statistical patterns. I will talk about this in detail in the next article. Here, I focus on the very logic of considering a market auction through momentum, fix, balance, and momentum.
The impulse is characterized by a stepwise accumulation of liquidity, a quick unidirectional change in price, and also hourly and daily turnovers increased by 25-40% relative to those in the balance sheet. Those. an impulse is a change in the value zone on the corresponding timeframe.
Gold is in the phase of momentum right now. Here is the hourly cluster chart of gold (Fig. 9) with daily profiles in mid-June 2019. The liquidity distribution every day is not normal (we look at daily clusters), i.e. in the range of the day, liquidity (kernels, balances) is placed unevenly. Each new day balance is higher than the previous one. Liquidity is placed quickly (several hours) in the plane. The normal distribution is broken on the higher timeframe and is observed only a few hours in a moment.
The current impulse began on May 30th. I do not understand the fact that this is the opening of a new two-month futures contract, I will simply indicate that at the time of the change of contracts or almost immediately after the change of contracts, the probability of a new trend is the highest. Until 1291.6-1294, it could be assumed that this is a blow to the balance. But the closing of the day (and it was Thursday) above 1291.6-1294 (the previous resistance range), as well as work on Friday at new levels 1301.8-1303.8 already hinted that it was time to join. The output of 1307.6-1311.6 at HIGH revolutions, confirmed by delta purchases, finally marked the impulse for the most cautious. Recent ranges of net purchases: 1318.8-1223.8 (can be divided into two zones, but this is not critical here) and 1326.6-1331.6. The first daily balance happened above 1324 already on Tuesday. Thus, over 5 sessions, gold went up by $ 80, after which the fix began.
Fig. 9. The phase of the pulse on gold. Hourly chart with daily clusters.
2. Fix (climax)
A fix is a surge of volume versus momentum. In classical analysis, this is the very correction expected by many.
How to determine the fix?
In the phase of an impulse, any horizontal volume (i.e., any accumulation, any balance at a younger TF) is directed strictly in one direction: in our case, this is a clear uptrend.
The first horizontal volume on the analyzed timeframe (TF), positioned in the opposite direction with the breakdown of the first supports in the pulse, is a fix. Horizontal volumes (clusters) may be negligible, but the vertical volume increases relative to the momentum. If in the pulsed phase each quotation expansion goes by 50-60 thousand revolutions per hour, then 70-90 thousand can be thrown to a fixed per hour. Well, there’s another 50 thousand nearby.
In other words, any reaction to discarded volume in the market AGAINST the main trend is a fix on the corresponding TF (or on younger TFs).
In our case, we see a whole day of balance at 1326.6-1331.6. The next day, the quotation expands to the north, but in the range 1347-1348.6 (Fig. 10), where they arrived without much struggle (i.e., very sharply), small volumes were thrown out and the first explicit fix occurred that returned the quotation immediately to 1326.6-1331.6. Through the session, the fix was confirmed by slightly expanding the price, but gaining volumes in exactly the same range 1347-1348.6. Volumes at these moments were maximum. The most intelligent came out in 1349.4-1351.8. It is also worth noting that on Wednesday two local hourly support 1338-1340 and 1340.8-1342.8 broke through, which should be held within the impulse. The second range showed resistance on Thursday's balance sheet. On Monday, June 10, it is already possible to position not only hourly, but also daily liquidity as a fix, since Friday closed above 1340, and actually opened in the region of 1330.
Fig. 10. General view of the fix. Hourly chart with daily clusters.
After the fix, balance always comes. It has a more or less long form depending on the phase of the market at an auction of a higher timeframe.
After the fix, a balance occurs on the considered TF. In our case, we can easily determine the boundaries of the medium-term balance. Balance is the accumulation of volume within certain boundaries after a fix.
The upper balance range is the liquidity of the fixes, and the lower one is the last purchases that pushed the quotation to the fixes. Those. it is more likely to expect the formation of a balance in the range 1316-1347 with calls no lower than 1318 and no higher than 1352 (Fig. 11).
Fig. 11. The beginning of the formation of balance after fixation. Hourly chart with daily clusters.
I repeat the thought voiced at the very beginning of the section: quotation analysis must begin with the older TFs and go down to the younger ones. The analysis period for senior TFs (day) is 1-2 years.
Most quotes on senior TFs are in the balance phase for several months or even years, so the analysis of senior TFs can begin with the balance, because will have to work in balance. But on younger TFs, only 4 phases are analyzed, where the first of them is momentum. You just need to remember that the market is fractal. And then entering the breakdown of the extremum, which seems like a good idea on the M30 chart, is actually a great idea for a deal in the opposite direction, because on the daily chart, the quote is at the edge of the balance.
The accumulation of liquidity in the balance sheet most often has a rotational form: inside the general balance after fixing on the younger TFs, support and resistance zones can be identified where intraday players are more active (Fig. 12). After balance, there is always an impulse in one direction or another.
Fig. 12. Formed rotational balance after fixation. Hourly chart with daily clusters.
The actual placement of liquidity in the balance sheet in question is as follows:
1321.8-1323.8 are the most aggressive buyers, below which it did not fall.
1325.6-1328 - zone of aggressive purchases at the very bottom of the balance, as well as the foot of the main buyers.
1329.4-1333.6 - the main buyers in the balance sheet.
1336.6-1341 is a zone of uncertainty, where there is a lot of liquidity, and it is positioned in both directions.
1344.8-1349.8 - zone of fixes and sales in the balance sheets.
It can be clearly seen that according to all the laws of the auction, buyers prevail at the top of the balance, and delta sellers dominate at the bottom. The struggle between buyers and sellers creates rotations, i.e. change of volume arrays. The breakdown of the fix zone on June 14 gave the first hint of a new buy impulse. The main argument of purchases was to keep quotes in the range of fixes, i.e. sales of the previous week 1344.8-1349.8. This positioning clearly indicated what the next impulse would be.
4.1. Impulse as a continuation of the previous trend
As I have already indicated, in 1344.8-1349.8 they scored the last buyers and left for the next impulse (Fig. 13). Now support was in the region of 1384, and the accumulation of buyers in 1393-1401. Zone 1417-1428 and 1440 acted as a zone of fixes. After the rotation of the purchase volume, they were accumulated exactly in the resistance zone inside the balance, i.e. in the zone of initial fixes 1417-1428. Today (August 5, 2019) the quote is storming 1470, i.e. entered a new impulse on the watch TF.
4.2. Momentum as a breakdown of the previous trend
As you may have guessed, the most important argument before the continuation of the dynamics is the expansion of the corridor in the direction of the previous dynamics (in our case, buy), followed by a set of liquidity in the former fix zone.
And how does scrapping happen? How to see it in the moment of balance on the corresponding TF?
Firstly, after 2 (less often 3) touches of the zone of fixes and the zone of the last aggressors to push (in our case, buyers) the quote should remain in balance. There should be a return under the range of fixes.
Secondly, the accumulation of liquidity in the younger TFs should go abruptly under the volume arrays on the corresponding TF.
Thirdly, there should be an expansion of the corridor below the support of the last buyers of the aggressors, albeit with a return to balance.
Fourth, after returning to the balance, the quote usually does not go above the POC (control point), i.e. most traded zone. The extreme zone where the quote can reach is the zone of fixes.
Fifth, after the impossibility of consolidating above the ROS, liquidity accumulates in the zone of former support OR (which is more reliable) slightly under the support zone. This is where we sell in the hope of breaking the trend.
Here is the gold chart again on July 30, 2017 (Fig. 13). This time, 20 minutes. After a certain upward trend above 1440, fixes begin, but support is drawn up at 1437.6-1438.8. Real fix arranged in 1444-1444.8. Please note that the first approach to the range gave a backlash, although there was no money there. When liquidity was gained in the range itself, the reaction turned out to be quite unequivocal. After the second call, a set of liquidity begins at 1442-1442.6. After this, the third call, again 1442-1442.6 and the extension to buy. But instead of fixing we see a breakdown of dynamics. If we were buying with the expectation of expansion to the north, then it's time to go out. Then we see a set of liquidity at 1440-1440.8, which is positioned on the short, breaking through 1437.6-1438.8. Under this range, a buyer appears who returns the quote to the balance with the fix test 1444-1444.8 without calling. The last attempt of buyers is to test from below already 1442-1442.6, where until recently they boldly bought. After that, the quote goes to 1429.8-1433.
Fig. 13. Scrap trends. 20 minute gold chart.
Carefully looking for sales could begin after the breakdown of 1437.6-1438.8 with a common stop over the zone of fixes. Conservative sales in this scheme are 1429.8-1433. Yes, yes, because this is liquidity to continue. We have the beginning of momentum, and this is the first liquidity, so we could safely sell it. There, the market did just that.
From senior to younger TF: an example of the correct analysis of quotes
So, let's look at the GC ticker on COMEX, which is part of NYMEX, which, in turn, is part of the CME Group. The analysis was carried out in mid-June. The analysis is conservative since at the time of preparation, the gold was transferred to the balance on the watch TF. The author managed to join the new buy impulse, which was already visible at the time of writing.
Weekly TF Analysis:
First, we analyze the quote from January 1, 2015, i.e. 4.5 years ago (Fig. 14). In 1 division of the price (cluster) I have 1 dollar instead of the standard 10 cents. The advantage of professional terminals, including the fact that you can compress the quote. I note that there is not only a summation of prices, but also a summation of volumes. As you can see, all 4.5 years the quote is in the balance phase after the collapse. The chart is weekly, it has contract separators (2-month futures on gold), and the dPOC indicator (dynamic point of control, a dynamic control point, which refers to the zone of the maximum number of transactions dynamically changing in time) is added.
Recall that the analysis must begin with impulse and fix, but for this you need to load a quote in more than 5 years, and this is not our planning horizon, right? The previous impulse is far beyond the horizon, therefore, we assume that gold has a multi-year balance: the quote calmly goes from the lower to the upper border, i.e. from 1201 to 1342, and exits abroad are regarded by players as an occasion to open positions in the opposite direction.
How to highlight the boundaries of the zone of value and balance, we already know. Just look where 90%, 70%, as well as 50% and 30% liquidity are placed. In this case, the cost zone is allocated at the extreme values of 1 million contracts in the cluster, and 1274-1297 is the core, i.e. the most traded part of the balance, judging by the presence of more than 1.4 million contracts in the cluster. In other words, the core is the most traded area, where 20-30% of the total volume is compactly collected.
Fig. 14. Analysis of weekly TF.
“Stop,” you say. "What else 1.4 million?". The core is the most traded zone, which is located just in the region of that same +/- 1 standard deviation. But the theory is theory, and practice suggests that we need to look for statistical patterns. More on this in the next article. Now just understand that statistics are important, not just the overall profile view.
Having defined the general mood, we need to highlight the areas of interest of the participants. Here are two customer areas. In the first zone, the range is 1189-1210, and in the second - 1244-1253. The core of the contract can already be positioned as support.
The areas of shorts in the 5-year balance are as follows: 1342-1355 and 1314-1327, which right now has become support.
Conclusions on the analysis of weekly TF:
- Gold is in a multi-year balance;
- Now gold has reached the upper limit of a multi-year balance;
- The response to the border is present on younger TFs;
- The border is reached impulse for 1 week period at the highest revolutions since October (about it in the next article);
- If the quote goes into the impulse phase on the weekly TF, then the former sales area 1314-1327 will become support;
- If the quote remains in the 6-year balance, then during June-July there is a high probability of balancing in the region of 1315-1345, or returning to the core 1274-1297.
Analysis of daily TF:
On the daily timeframe, we observe an impulse in the balance, which can turn into an impulse on a weekly TF, and can end, taking into account the analysis of a long-term balance and occurring fixes. Two ranges 1338.5-1342 and 1345-1348.5 were unloaded. Support 1327.5-1331.5 - balance day (Tuesday, May 4). We can not break below, while there is a set of shorts at a small turnover. According to the law of the auction, this may indicate that a potential bottom of the forming balance has been found.
Fig. 15. Analysis of daily TF.
At the same time, Monday (or rather, Sunday in the USA; if you did not know, then in the USA trading starts on Sunday, when we have midnight from Sunday to Monday) 1338.5-1348.5 left the core of last week. In order to expect the continuation of the buy impulse after consolidation, the quote should not go below 1327.5-1331.5, although 1319.5-1323.5 are acceptable, but they open up new probabilities.
Conclusions on the analysis of daily TF:
Buy impulse is not canceled, primary fix is available. Buy priority remains, but after the formation of a reliable platform. Therefore, now the benchmark is the balance for 3-5 days. We will observe.
Analysis of hourly TF:
But I will not conduct it. Just re-read the previous section. There, an analysis based on an hourly TF was carried out. Therefore, I will immediately proceed to the conclusions.
Conclusions on the analysis of hourly TF:
Watch fixes took place in the zone of perennial fixes. The upper bound is taken into account. The quote works according to the rules of the auction.
Highlight the auction phase: instead of homework
Here is a chart of Texas oil from January 1 to mid-June 2019 (Figure 16).
- Highlight market phases on the oldest TF;
- Find local fixes and consolidations;
- Find the balance sheet for 2019;
- Based on the position of quotes in the balance sheet of the year, determine the potential direction (and do not look at the oil chart, everything is clear here, if you remember about the auction).
Fig. 16. Oil. Daily TF from January 1, 2019.
Waiting for answers under the article.
Conclusion How to put into practice the knowledge of the auction structure?
Very simple. First repeat the mantra: “impulse-fix-balance-impulse”. Then follow these steps:
- Analyze from the higher timeframes to the younger ones: determine the market phase on the senior TF, average TF, younger TF (day for year, hour for month, 15 minutes for 2 weeks). Compare the results;
- Estimate the prospects for entering the market based on the market phase. In the gold example, I showed in mid-June that there was an EXTREMELY INTERESTING place to enter in the medium and long term, because phases coincide on all timeframes;
- Determine the entry point, stop and profit and wait for the moment. Or launch your strategies. But only after evaluating the prospects.
In general, everything is simple.
And again the main idea. Out of balance, i.e. an impulse implies a quick and aggressive set of liquidity in the plane beyond the borders of the balance, preferably far enough from the border. The most reliable entry is after precise positioning of liquidity: to continue or to return. And then on the test of precisely this liquidity you can enter, i.e. buy high / sell low if liquidity is positioned as liquidity to continue; or sell high / buy low if liquidity accumulated outside the balance sheet shows a return.
In the next article, we will supplement knowledge with objective parameters, i.e. values of vertical and horizontal volumes that allow you to enter the market together with a major player, because a full analysis of the structure of the auction is impossible without studying the exchange volumes.