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Basics of order matching mechanism

To deeply understand Footprint/Orderflow concepts... first, more important than auction theory is the order matching mechanism, a mandatory element that occurs in every "auction".

Very basic, we can understand as follows:

1. Basic order types: basic orders are orders that any trading platform uses, or we can simply see them commonly on the platforms we still trade such as MT4, MT5, including : Limit order, Market Order, Stop Order.

2. The trading principle is carried out as follows: Limit order will match Market order, that is, limit order always matches market order in the opposite direction.

For example: Buy limit BTC at 43000 will match Sell market BTC at 43000 (in ideal conditions without spread)

Limit order never matches Limit order.

3. TP (Target profit) and STL (Stoploss) are also a type of order, in which, STL is always a Market order, TP is divided into 2 types, if TP is executed immediately it is a Market order, fixed TP is Limit command.

4. Expanding from the above basic concept, we can explain most basic market phenomena such as absorption, price imbalance, profit taking, stop loss hunting, etc.

Auction Market Theory

0. Why is auction market theory important?

A core understanding of auction theory will enhance your ability to organize ideas, recognize patterns, address valuable questions, and extract essential pieces of data from endless amounts of information. It also helps us bring the views of many market participants into a unified whole.

Traders who do not study or understand the basic concepts of Auction Market Theory will always try to predict the market rather than react to the information the market provides them. When you trade a strategy that you don't understand the fundamentals behind or the logic of why it works, you will lack confidence in it. However, Auction Market Theory is just the beginning to understanding fair value, disequilibrium, and other order flow trading concepts.

1. Concept: Auction is a general theory, here, it is said that the market (Market - MK) moves higher and lower due to the imbalance between buyers and sellers (caused by market events) until the price discovers the level of equilibrium and the transaction can be most facilitated (Fair Value).

2. Example of auction market theory

Car buyers want the lowest price for new cars while dealers want the highest price to maximize profits.In the example below, the current price of a new car is $35,000 (Fair Value). Some buyers will pay a little less than $35,000 while others will pay a little more due to negotiation, but the average will remain close to $35,000 until a market event occurs .

1.1. Fair value is the price range that creates the most favorable conditions for transactions between market participants. Tightly balanced buyer and seller participation results in prices trading in tight ranges with higher volumes. When a security is trading at a reasonable price, it is in equilibrium.

1.2. Most Market Profile configurations use 70% of session volume (instead of 68.2%) to determine Fair Value where the control point is used as the average value. The point of control is simply where the most transactions take place, as indicated by the greatest volume. Particularly for the TPO (Time Price Operations) chart, POC is determined as the point where the most transactions occur in a period of time.

1.3 . Therefore, prices above or below fair value with high volume are considered "unfair" prices (i.e., do not accurately reflect the true intrinsic value of the security being traded).

Disequilibrium occurs in the market due to market events that cause buyers or sellers to become dominant.We can rely on a number of factors to determine the superiority of buyers and sellers by analyzing price, volume, Delta, Liquidity....The goal of pro traders is to determine whether the market is in balance or imbalance and then apply an appropriate trading strategy based on that analysis. The orientation is as follows, in balanced markets, focus judgment and establish positions around the Fair Value zone. Conversely, when the market is out of balance, it means the price has left the fair value zone, or waiting for confirmation of the participation of the next buyers or sellers, or waiting to continue a fair value zone. 

1.4. When the market is in the discovery phase in a state of buying imbalance, buyers will push prices higher to find new sellers. In the same way, when a selling imbalance occurs, sellers will push prices down to find new buyers. In short, it will revolve around the formula: Fair Value - Imbalance - Fomo (discover new value areas)

Absorption is a “phenomenon” that shows disproportionately high trading volume with negligible price movement behind that level .

Mainly, we have 02 types of absorption:

1. Selling absorption occurs when the selling amount in the market (active - Market Order) touches the limit buying amount, this buying force will absorb the selling side's supply.

2. Buy absorption occurs when the market (active – Market Order) buy collides with the sell limit, which absorbs the buyer's demand. The role of passive buyer or passive seller of large volumes is usually performed by large professional traders or institutions with significant financial resources. It allows them to trade large limit orders in the market at those prices, the prices they are interested in, with the most “discreet” market footprint. Figuratively speaking, they 'sit' on these prices and absorb supply or demand, created by the market orders of Retail - Traders.

Example 1: [Image below] The cluster of candles from 13:00 to 14:30 this afternoon, code XAUUSD (GC), observing we will see very large negative Delta levels of 100-103-104 at the bottom of the candle bar, especially in that , candle number 1 forms a "b" configuration, signaling strong accumulation and absorption of Buyer Limits. Combined with the "attractive price" standard, candles number 1 and number 2 show that the attractive price shows signs of "increasing", this is a very important factor to be able to set up an order.

Example 2: [Picture above] Absorption fails, as I said in example 1, if for a normal Retail-Trader like us, absolute detection of absorption is not feasible, so There are many cases of "reverse" absorption, meaning that the Limit side "thought" to be dominant but was trapped. The way to handle it is very simple if you have carefully viewed and understood the "attractive price - auction zone" that you As mentioned before, we immediately see the "attractive price zone" gradually getting lower. In this case, if the "machinery" buys according to absorption, the loss rate is very high.The causes of this situation are quite diverse. It can be briefly explained as due to an imbalance in supply and demand or buying and selling. However, one thing to note is that it is not always imbalanced in supply or demand. strong demand, but it could be because one side is too weak. I will explain this in more detail later on about active and passive imbalance.