Skip to content
GetProfitable
Search

The auction and the two-sided market

Lesson 3 · about 9 min

A market is a continuous two-sided auction. That phrase gets repeated so often it has lost its meaning, so this lesson takes it literally and shows what the auction is doing minute by minute. Everything in Module 4 about volume profile is built on this idea, and it only makes sense if the auction is real to you first.

What an auction is for

An auction has one job: find the price at which the most business can be done. In a house auction the auctioneer raises the price until only one bidder is left. A market does the same thing in both directions at once, all day long.

  • Price moves up to find sellers. If it goes high enough, sellers appear and buyers stop lifting. Price stalls.
  • Price moves down to find buyers. If it goes low enough, buyers appear and sellers stop hitting. Price stalls.
  • In between, where both sides are willing to trade, volume accumulates. That region is what auction theory calls value.

The important reframing: a rally is not "buyers winning." A rally is the auction advertising higher prices to attract sellers. It ends when enough sellers show up, not when buyers give up. Likewise a sell-off is the auction advertising lower prices to attract buyers.

The auction in the book

Here is a stylised sequence of a market probing higher. Each column shows the trades that occurred at each price in a short window, split into buyer-initiated (at ask) and seller-initiated (at bid).

  Price   | Sold at bid | Bought at ask | Read
  --------+-------------+---------------+---------------------------
  5003.00 |     310     |       40      | sellers overwhelm; probe fails
  5002.75 |     180     |      120      | buying slows, selling grows
  5002.50 |      60     |      210      | buyers still lifting
  5002.25 |      45     |      260      | strong buying
  5002.00 |      50     |      240      | strong buying
  5001.75 |      90     |      150      | buying begins

Reading from the bottom up: buyers lifted offers from 5001.75 to 5002.50 with little opposition. At 5002.75 sellers started to respond. At 5003.00 the sellers were three hundred contracts against forty; the auction found the price where sellers were plentiful and buyers were not. It will now rotate back down to look for the other side.

That is the whole auction, in twenty seconds of trading. Scale it up to a full day and you get the day's high, low and value area. Scale it to a week and you get a weekly range. The mechanism is identical at every time frame.

Key idea: A move up is a search for sellers; a move down is a search for buyers. The move ends when the search succeeds. Watching where the other side shows up is more useful than watching the move itself.

Balance and imbalance, briefly

When the auction has found both sides and rotates between them, the market is balanced. Price goes up, meets sellers, goes down, meets buyers, and repeats. Volume builds a bell-shaped hump in the middle.

When one side is absent, the market is imbalanced. Price advertises higher and no sellers come. It advertises higher again. Volume is thin at each price because nobody wants to trade there; everybody wants to trade later, at a different price. Trends are imbalance in motion.

State What the auction is doing What volume per price looks like
Balance Rotating between accepted highs and lows Fat in the middle, thin at the edges
Imbalance Travelling to find a missing side Thin everywhere until it stops
Transition Leaving balance or settling into it Thin then fattening, or the reverse

Module 4 gives these precise names and shapes. For now, the concept is enough: when you see price stall and volume build, the auction has found two-sided trade. When you see price move quickly on thin volume, one side is missing and the auction is still searching.

Why this matters for a retail trader

You cannot control the auction and you cannot see all of it. But you can identify what state it is in, and the two states demand opposite behaviour:

  • In balance, fading the edges (selling near the top of the range, buying near the bottom) is trading with the auction. Buying a breakout of the range is trading against it, until the breakout proves itself.
  • In imbalance, fading is trading against the auction. Joining pullbacks in the direction of travel is trading with it.

The most expensive mistake in this whole subject is applying balance tactics to an imbalanced market: shorting "resistance" while the auction is still searching for sellers and has not found any. Order flow tools exist to tell you, in real time, whether the sellers have arrived yet.

Try it: Pick any chart with volume on it and find a period of two or three hours where price went sideways. Then find a period where it trended. Without any indicators, describe in one sentence each what the auction was doing and where it found the other side. If you can do this with plain candles, order flow tools will sharpen the picture instead of confusing it.

Recap

  • The market is a two-sided auction whose job is to find the price where the most business can be done.
  • Rallies search for sellers and end when they are found; sell-offs search for buyers.
  • Balance is a rotation between accepted extremes; imbalance is travel to find a missing side.
  • Volume per price is fat in balance and thin in imbalance.
  • Tactics for balance and imbalance are opposites; identifying the state comes before choosing a trade.

See it drawn

Original diagrams for the ideas on this page. Illustrative, not real market data.

A range beside a trendOne chart swinging between a flat floor and ceiling, another stepping upwards inside a pair of sloping lines.Range-boundresistancesupportprice bounces between two levelsTrendingthe trend channelhigher highs and higher lowsA range has two flat edges; a trend has two sloping ones.
Range versus trend. On the left price keeps bouncing between the same floor and ceiling, which is a range. On the right each high and each low is higher than the last, inside a pair of sloping lines called a channel.
A volume profile beside a price chartA price line on the left and, on the right, horizontal bars showing how much volume traded at each price; the longest bar marks the point of control and a shaded band marks the value area.52.051.050.049.0timePRICE OVER TIMEVOLUME AT EACH PRICEVALUE AREAwhere most ofthe volume tradedPOCthe single pricewith the mostvolumeLonger bars mean more shares changed hands at that price.
Volume profile, point of control and value area. Turn the chart on its side and count how much traded at each price instead of at each moment. The longest bar is the point of control, and the shaded band around it is the value area where most of the session's business was done.
Breakout and retestPrice stalls under one level, pushes above it, comes back to touch it from above, then continues higher.pricetimeold resistancenow support1price keeps stalling2breaks above3pulls back and retests it4and carries on
Breakout and retest. Price stalls under the same level several times, pushes above it, then drops back to touch it from above before carrying on. That touch is the retest, where the old ceiling is tried as a floor. A break that falls straight back under it is a false breakout.