Auction Market Theory

Auction Market Theory

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Auction Market Theory

The idea and practice of fairness between buyers and sellers.
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Imagine being at a swap meet and you see someone wanting to buy a motorcycle part.

The Components

  • Price: Advertises opportunity
  • Time: Regulates opportunity
  • Volume: Measures the success or failure of an auction at different price levels

The Environments

There are two types of environments in a market — balance and imbalance.

Balance

In a balanced environment, buyers and sellers agree on buying / selling at the current prices. When this happens, these price levels are considered fair value (AKA the value area), which is 68-70% of the range.

Balanced environments are typically slower in movement with lower volatility — like being stuck in traffic on the freeway. At some point, traffic frees up and you’re back doing +65mph. This is when price leaves a value area, creating an imbalanced environment.

Imbalance

In an imbalanced environment, price is typically trending in one direction (either up or down), giving control to aggressive buyers when price is bullish and going up or to aggressive sellers when price is bearish and going down.

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Using the image above as reference, imagine there are three different house parties raging on the same night. Everyone’s currently in House A having a good time. Then, word gets out that there’s an even better party a few blocks away at House B. So everyone from House A dips and travels over to House B to have a good time for a while. And the same process happens again, but at House C and will continue to repeat and repeat.

Statistically speaking, markets will be in a trend 20% of the time and spend the other 80% in a consolidation / range, AKA the Pareto Principle.

The Activities

When price breaks out of a balanced environment (fair value), there are two types of activities that may happen — responsive and initiating.

Responsive

Going back to the house party analogy, imagine you’re in House A with your friends and having a good time. But one of your friend hears about House B’s party and decides to leave, even though you want to stay at House A. So as they’re trying to leave, you’re stopping them; convincing them to stay at House A. And if they’re a good friend, they’ll stay.

That’s a responsive activity — price is attempting to break out of a fair value area but is quickly stopped by responsive participants (either buyers or sellers, depending on which direction it was trying to break out of), continuing to trade within the 68-70% range level.

Initiating

The opposite of a responsive activity is an initiating activity — where price breaks out of a fair value area, only to continue trending until it finds the next fairest environment

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