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Auto Balance is a color picker that removes a highlight color cast by clicking on a close-to-white area in the Preview Window. The parameter will then set a color that balances out the Red, Green and Blue components to make that white area neutral. When choosing to use this control, it should be the first one set, even before adjusting the 3-Way settings, and is considered a typical first step to fixing any coloring issues within the footage.
Use the eyedropper tool to explicitly define what's considered the white point in the image. Auto Balance then tries to correctly set the shadows and the highlights, and also corrects for the black point based on the white point provided.
Auto Balance only affects the shadows and highlights of the source footage; it does not adjust for the midtones. The white point in the Highlight wheel and black point in the Shadow wheel move correspondingly, while the Midtone wheel does not change.
An alternate use for Auto Balance is to click the color chip and manually define the color. This method sets that color to explicitly tint the image. Opting for this alternative use is typically to compensate for the perceived color tone; for example if the color is too hot, choose a blue color chip to turn the image more orange (its opposite on the color wheel).
Workflow Tip: Typically, the most accurate way to sample a white point is to click in the sclera, the white area of someone's eye. If the sclera is too shadowed (as in the example below) then sample from the whitest possible point of the image.
Top to bottom, the original image and image after Auto Balance. Red X marks the sample area. Notice the changes in the Auto Balance color chip, Shadow wheel and Highlight wheel.