What is the Auction Market Theory
Auction Market Theory serves as the fundamental framework for order flow trading. Integrating this theory into your market analysis can effectively filter out unnecessary noise and uncertainties.
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📍Auction Market Theory, developed by J. Peter Steidlmayer and expanded upon by Jim Dalton in his book Mind Over Markets, explains how financial markets function as auctions where buyers and sellers interact.
The theory focuses on two main objectives: facilitating trade through a two-way auction process and determining the fair value of assets. Supply and demand dynamics and price discovery play a crucial role in this process. Auction Market Theory is represented using tools like Market or Volume Profile, which utilize bell-shaped curves to identify the value area, representing 68% or 1 standard deviation from the mean.
🔷 In a balanced market, buyers and sellers agree on prices based on their perception of fair value. This leads to lower volatility and prices that remain relatively stable, resulting in a ranging market. The fair value can be recognized using the Market or Volume profile, which appears as a Gaussian bell-shaped curve. However, financial markets rarely stay in balance indefinitely. New information, whether fundamental or technical, causes markets to move away from fair value and transition into a different environment.
🔷 Imbalance refers to the opposite of balance, where there is a disagreement about fair value. In this scenario, one side of market participants becomes more aggressive, leading to a trending market. Typically, markets tend to trend only about 20% of the time and range about 80% of the time. When the market is within the value range, it is more likely to remain in balance and explore within that range. However, in the case of an imbalance, the market often drifts higher or lower until it reaches a stop, typically within a previous value area.
💥Key Takeaways:
🔸 Auction Market Theory explains how financial markets function as auctions, focusing on facilitating trade and determining fair value.
🔸 Supply and demand dynamics and price discovery are essential in the Auction Market Theory process.
🔸 Tools like Market or Volume Profile use bell-shaped curves to identify the value area, representing 68% or 1 standard deviation from the mean.
🔸 In a balanced market, buyers and sellers agree on prices based on their perception of fair value, leading to lower volatility and a ranging market.
🔸 Financial markets rarely stay in balance indefinitely, as new information causes them to move away from fair value and transition into different environments.
🔸 Imbalance occurs when there is disagreement about fair value, leading to a trending market.
🔸 Markets tend to trend about 20% of the time and range about 80% of the time.
🔸 When the market is within the value range, it is likely to remain in balance and explore within that range.
🔸 Imbalanced markets often drift higher or lower until they reach a stop, usually within a previous value area.
