Market Profile of the SP 500 at a Critical Juncture

Tom Alexander

Tom Alexander

In the article I wrote a couple of weeks ago we took a look at an objective means to identify a potential change in market condition and the specific signal from the perspective of auction market principles and the Market Profile™ graph that would have to occur that would be an initial signal of the beginning of a correction in the four primary trading indices. This week we will take a look at the S&P and see what has transpired since our last article and what new information we have that may be useful to traders.

In that article I said, “At this point in time, the initial signal of a potential correction being underway is a close below the low of 10/19 at 1086.48”. That event occurred on Friday, October 23. The close below 1086.48 was significant because it represented a close below what the market had determined as Value to that point. Since 10/23 the S&P has continued to have its areas of Value migrate lower, and last week saw the most dramatic decline since early October.

S&P 1

As Value continues to move lower, the S&P is reaching a Key Reference Area (an area formed in the auction process that has been either high volume on the horizontal scale or low volume on the vertical scale). KRAs are inflection points from where a greater than typical reaction is most likely to occur. Focusing on trade location in this manner consistently provides optimal trade location, i.e., optimal edge. The immediate downside KRA below Friday’s close is 1030-1017, basis cash. This area includes the late August Balance Area that formed a temporary top and the subsequent test of the September breakout of that area that occurred in early October. If 1018 is taken out the S&P will likely trade sharply to 1000.

Notice I am showing these levels on a bar chart. “Market Profile™” traders too often miss the bigger point of this form of analysis by focusing almost entirely on profile graph charts. The profile graph is a means to an end, not the end itself. It is a tool of auction market analysis and a very useful one. However, one should not lose site of the fact the “magic” is not in the charting format but rather in the uniqueness of the perspective of market development that auction market principles provide. Very often a clearer and more helpful view of market behavior can be seen using a bar chart rather than a profile chart. This is especially true when a market has been in a vertical phase of development and there is little recent horizontal activity.

Bar S&P

The upside KRAs are 1051-1054.90 (single prints), 1064-1070 (includes highs from 10/28-10/30 and the HVN of 10/26-10/27) and the line in the sand for any immediate-term bearish case is 1094-1098.


So what’s next? I don’t know. But I at least know I don’t know. The good news is that as a trader I do not have to know, or to predict the future, in order to make money. This is an extremely critical difference between analyzing a market through the lens of auction market analysis and any other type of analysis. Auction market analysis is present tense; it does not look back and extrapolate forward as do both fundamental and technical approaches to market analysis. The only thing that auction market principles “predict” is that when one of the two phases of market development completes the next will begin. It focuses on identifying present market condition which enables the trader to apply appropriate strategies and tactics for that specific market condition. As a trader all I am trying to do is to identify trade location from where I am more likely than not to get a move larger than randomness that gives me an edge over a 1:1 reward to risk. If I can consistently identify trade location with reward to risk opportunities with 1:4, 1:6, 1:10 and greater consistently I have an edge, even if I flip a coin to determine whether to go long or short.

The stock indices are very “oversold.” (“Oversold” and “overbought” are two very dangerous labels. Always remember they are relative terms). We do analysis on market internals to help give an inside read of what is going on in the market. Our breadth work is at levels suggesting at least a short-term bounce from near present levels should be respected. If this bounce occurs into one of the upper KRAs (potential resistance) displayed above it may be a good opportunity for shorts. If there is no bounce and the S&P continues to crater we’ll evaluate opportunities on a trade into 1030-1018.

Here is a link to Monday’s Daily Briefing and Strategy Analysis. For those that are interested among other things it provides KRAs for the four primary mini stock indices futures contracts.

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Want more Market Profile with Tom? Try this post:

A Review of the Major Stock Indices Through the Lens of Auction Market Principles and the Market Profile Graph