Initial Balance

We first discussed initial balance in 1990 with the publication of Mind over Markets; we had
been introduced to the concept by J. Peter Steidlmayer, the original developer of the Market
Profile® along with the Chicago Board of Trade in the mid to late 1980s. Initial balance was
defined as the price range resulting from market activity during the first two thirty minute time
periods.

Early in the session, on those days that lacked early interest by longer-term market participants,
locals, i.e. floor traders, would attempt to auction the market higher until they encountered other
timeframe sellers. Having located the upper end of their initial exploration they would reverse
course and begin to auction the market lower in an attempt to locate the other timeframe buyers;
once this was accomplished the “initial balance” or “bracket” was in place. The concept of initial
balance was not applicable on those days that the longer timeframes were active from the
opening bell.

On those days that an initial balance existed, it was a scalper’s paradise, at least until such time
when longer timeframe traders or investors began to become active. When the market began to
auction outside of the initial balance, change was occurring and auction activity would increase.

Markets have evolved and the concept of locals being able to exert control appears to be history.
Yet the concept of initial balance, as it refers to a base on which a market sometimes develops, is
still a useful tool for traders today.

Over the past 20 years we have continued to refine the concept of initial balance, modifying it to
fit current market dynamics. Here we will discuss two types of initial balance and the
environments they are found in that are of value to traders today.

Review

As we touched on earlier, the original concept of initial balance as it was described in Mind over
Markets was the price range resulting from market activity during the first hour for most
commodities and slightly longer for the S&P’s; it represented the period of time in which the
locals attempted to find a range where two-sided trade could take place. At that time locals
provided liquidity, not direction, by acting as middlemen between the off-floor traders. We used
the analogy that the local is like the car dealer—the middleman between the manufacturer and
the consumer—with the goal to move inventory quickly and make a small profit on each sale.

Following are the Day Types, slightly updated, that were originally discussed in Mind over
Markets; understanding these will help lay the groundwork to interpret initial balance in context
and what we might expect as the session develops.

Initial Balance with Regard to Day Types:

1. Primary day—formally referred to as a Normal day—wide initial balance mostly

contains the extremes for the day. These days are more the exception than the rule.
 2. Variation of a Primary day—the initial balance in the early session is less dramatic.
Later in the day this narrower initial balance experiences range extension on one extreme
as a longer timeframe enters the auction.
3. Double distribution trend days—the initial balance forms a narrow base in the earlier
part of the session reflecting a low level of conviction; said another way, a price area
where two-sided trade is taking place. Buyers and sellers are in agreement as to the fairest
price to conduct business. The narrower this base is, the easier it is to overwhelm it if a
longer timeframe enters the auction; prices are driven to a new level, establishing a
different value area later in the session.
4. Balanced Days—formally referred to Non-trend days and Neutral days in Mind over
Markets—early in the session, this day is similar to a double distribution day in that the
base is narrow, but prices stay contained and the range is never extended. These days
tend to develop before the release of big economic numbers or announcements. They
signify a market that has come into balance and/or a market awaiting more information.

Initial Balance: Two Most Important Factors

In today’s markets there are two types of initial balance that are most important to guide your
trading:

1. Rotational, low conviction days where the base is more narrow

2. Trend days (not including double distribution trend days): When a market starts to trend
off the open—there is no initial balance—there is no balance; normally the market is
auctioning directionally from the opening. Attempting to apply the initial balance concept
will likely place you counter to the trend day.

As we continue this discussion I encourage you to think about initial balance conceptually (such
as a narrow base but not necessarily tied to a specific amount of time), considering the market
open along with other market-generated information (MGI). Employing initial balance with a
linear approach leaves little room for imagination, gaining experience, and being able to apply
this concept successfully over the long term in your trading. Using a more conceptual
understanding will help you to internalize initial balance and begin to sense the dimension of the
base and what this suggests.

Initial Balance Range or Base

Initial balance is valuable on rotational days particularly those that have considerable overlap
with the prior session. As we recognize what timeframe is likely dominating by gauging price
behavior around references, tempo, and other MGI, initial balance provides areas to gauge for
auction acceptance or failure and potential good trade location. Remembering that the high or
low are often made in the first 90 minutes can also help visualize possible scenarios and
formulate the most appropriate trade strategy and tactics.

Once we determine the environment that we are trading in we can consider the range of the
initial balance. As we mentioned earlier, narrower ranges are easier to overtake and therefore
increase the odds of range extension and perhaps result in a double distribution trend day. A
narrow initial balance range can also convey a market that is in balance and awaiting more
information before probing higher or lower. Let’s look at a few market examples to illustrate
how to employ initial balance information by contrasting the various range extremes:

S&P 500 E-mini on Monday, October 11th: Narrow Initial Balance

The E-mini S&P shows a narrow base, but it also allows us to move a step further and discuss
initial balance more conceptually rather than linearly. Initial balance is defined as the first two 30
minute periods in most markets and slightly longer for the S&Ps—this is linear. A conceptual
understanding considers the time spent in range and the tone:

 If the initial balance is narrow in a rotational market, we know the easier it will be to
knock it over; we prepare for this with our trading scenarios.
 However, if the initial balance is narrow and maintains this balance for several periods,
the longer this goes on, the odds are that a price migration away from this balance will
not be lasting.

A more conceptual understanding will afford you a greater appreciation and help you visualize
various scenarios as the session goes on.
30 Year Treasury Bond October 14, 2010: Narrow base overtaken—Double Distribution
Day

The narrow initial balance led to a rather dramatic breakout to the downside. Balance areas set
up three scenarios:

1. Stays in balance
2. Upside or downside breakout that fails; destination trade is opposite end of balance
3. Upside or downside breakout is accepted—indicating a “go with trade” in the direction
of the breakout.
Visualizing possible outcomes and how you can capitalize helps you anticipate; the narrow
initial balance suggested what was possible and gave you time to prepare.

S&P 500 E-mini on Friday, October 15, 2010: Wide Initial Balance

The wide initial balance contained the range for the day, a more unusual occurrence. As the
thirty minute auctions printed we could see a market coming into balance—the odds were that
trade opportunity and profits would be small. There were good day timeframe trades however
understanding the environment would alert you to the importance of trade location and smaller
trade expectations.

Summary: The valuable and practical observation is to recognize that the range of initial
balance—its base—can help you visualize possible scenarios, gage your expectations, and guide
your trading as the auction continues. These examples present different scenarios that illustrate
initial balance variations and what to consider as the initial balance is forming.

Trend days

Initial balance has little relevancy when this day type unfolds. Actually, it is not only irrelevant,
but employing initial balance on trend days can actually hamper your ability to execute. On a
day when there is directional conviction at the bell with an opening drive that begins to one-
timeframe higher, initial balance is of little use and can distract you from observing the most
important market-generated information. Let’s look at an example:

S&P 500 E-mini on Monday, September 24, 2010:

We opened out of balance to the upside which gave us the opportunity to consider trend day
scenarios. Using initial balance in this market situation did not enhance your market
understanding or ability to trade this market; the more important, resonating information was the
open out of balance followed by rejection into the prior session range.

Over the years some service providers have attempted to adapt the information in Mind over
Markets as a basis for statistical, linear measurements to quantify initial balance, using averages,
ranges extensions from it and other computations to create tactical buy and sell signals. In light
of what we have discussed, we find these methods somewhat compartmentalized and ultimately
limiting in one’s ability to trade successfully over the long term. There are many conditions that
must be considered, not only in the day timeframe but broader market conditions, to effectively
employ initial balance in your trading strategy. Initial balance is most effective when it is
considered in context with other developing dynamics in the market.

In the twenty years since I first wrote about initial balance in Mind over Markets, it still today
provides excellent information. However as I have tried to introduce here, my perspective of
initial balance has evolved to have more depth. If you can observe initial balance more openly
and consider the contextual conditions around it, you will gain experience, begin to internalize it,
and have better odds of employing it successfully in your trading.