TraderNovice.com
Market Profile is a charting technique which presents the data in a format that will greatly aid your efforts to understand market behavior. (You can refer to one of my favorite books on the matter MIND OVER MARKETS in tradernovice's Book Review section).
Traders have developed various tools to aid in assessing the behavior of the market. The most common tool of course is a simple price / time bar chart on which the high, low and close of a given period is plotted. Other common options include candlesticks (for better visual reference), Equivolume (showing volume with widths of bars), Point and Figure (with no consideration of time only price change) and of course others (Kagi, Renko). In addition to these various charting styles, many traders utilize overlays of indicators as well. The reason for different charting methodology is simply that all traders do not see the markets the same way and what best aids one trader, may not be best for another.
Market Profile charting is another way of visually referencing market behavior. It too, is a price / time chart, with the time periods typically 30 minutes, and those periods being labeled alphabetically as on the exchanges (initial period A, second thirty minute period B, etc.; reference lettering may vary between exchanges and data providers but refer to 30 minute periods). Every price at which a trade occurs in A period is labeled with an A, thus creating a vertical line of A's extending through various prices (see chart on right).
Once the next time period begins, all prices at which a trade occurs in the next 30 minutes will be labeled B, again creating a vertical line of prices labeled B (see chart on right). This process continues until the close. At the completion of a trading day, the completed chart details some prices that were only visited during a few time periods, but other prices at which trading occurred in many periods. This typically creates a curve similar to a bell curve distribution . The prices which were visited most often are interpreted as "fair value". Those prices visited only once or twice during the day are thought to be outliers, areas where that price represents an advantage to either sellers or buyers (see chart below left with yellow box being "value area" and upper A prints and lower K prints being viewed as outliers). Combining this structure with volume analysis can aid in better understanding which prices are viewed as fair value and at what other prices an advantage may be gained. Therefore Market Profile Charting is nothing more than a visual representation of the days price activity.
With that said, What is the advantage of using Market Profile. Well, remember in school when you always had one teacher who could explain things in a way that you could understand? For me, and for many traders, The Market Profile Chart is like that teacher. It really does not give you any more information than any other method of charting. It simply provides that information in a very different format, filtering out much of the noise of the market, and in so doing may help you understand market behavior more clearly.
Generally, markets trade in a back and forth fashion within some range. Trends happen, but are less common. That being the case, usually the bell shaped curve is going to apply to the profile chart for a given period of time. On the upper and lower ends of the profile you may see vertical notation of several prices that occurred in only one time period. These are known as "tails" and imply that price entered that area, but was quickly deemed unfair and pushed back towards the mean by sellers or buyers. The largest area of the chart however will have many letters for each price and this is known as the "value area" (YELLOW BOX IN LEFT PROFILE) comprising 70 percent of the volume for any given day or time period. Most often day traders will have primary interest in the current day's profile chart. However value areas, balance, buying and selling tails, and the like can be viewed over longer timeframes as well. This can be done by utilizing adjacent daily profile charts (see balance chart below), or by compressing the profiles of multiples days into one large profile. It can be enormously helpful to view market behavior in this fashion, providing context for interpreting the current day's action.
A trader utilizing the Market Profile Charting Method will, whatever the time period, recognize an area of percieved value and judge further price activity based on that perception. Prices that venture above the area will be viewed as likely too high, and he will look for the market to push those prices lower again. Whether that occurs and the rate at which it occurs will give clues to the market's intentions. If, for example, the markets have developed a two week trading range and that is clearly represented by cumulative market profile charts, and then one day the market opens below that range (and of course value area), it will be said to have opened below value and the trader will expect buyers to enter the market quickly, viewing this as opportunity and pushing price back to value. That may indeed happen or the market may simply have changed for any of a variety of reasons and the trader will then be quick to recognize that change, should price not move as expected. Should the open have occurred within the value range, it would be said to have been in value and no quick move would be expected. And of course finally, in the same situation with the market opening at a price above the charted range, it would be said to have opened above value, and the trader would expect sellers to enter the market and push prices lower, back into the value range.
Markets however, do not remain range-bound forever. The Market is nothing more than the cumulative total opinions of all those choosing to participate with trades at any given time. That cumulative opinion of those who participate is affected by an enormous variety of conflicting and difficult to interpret information, making predicting change based on fundamental information near impossible. Nonetheless, the cumulative view of participating opinions is not static. It changes second to second and minute to minute, so the trader must recognize that any given bell distribution represented by the Market Profile, though good as a reference, can quickly change. Thus the Profile distribution is not expected to be thought of as an absolute reference, but rather as a relative starting point which represented the cumulative opinions of those in the market at a previous time, and against which, new market information can be compared. When price action tests the high or low end of a profile value area, the trader must decide whether a break or a retracement is more likely. In making this decision he will consider volume traded, time spent in the breakout area, number of attempts at a break, activity of similar and dissimilar markets (such as equities and oil in current climate; or ten year bond and thirty year bond), and other information such as extraneous factors like news items that may have spurred the test. The Market Profile Chart will not tell you if a break will occur. It will however, give you a reference.
One key to understanding market behavior is recognizing that price alone often does not give nearly enough information. It must be viewed in context. What volume traded at that price? How did the market get to that price? How long has it traded at that price? Has it traded at that price in the recent past? etc.
When I have been away from the markets and then I find out that the Dow was up 300 on a given day what does that tell me? Not much. I need so much more information. Where was the market trading? Had it been trending or range bound? Where was the market in relation to its range if so bound? If the market was up 300, how did it get there? (did it go up 50 pts. / hr for six hours or did it go up 700 points on big news at the open, only to fall back down slowly during the day. Price is one component of understanding market activity, but there is so much more. The profile tries to give you that more in a concise, visual format. In my opinion it does so.
There is much more learning information at WindoTrader.com.
A typical range bound day consists of the market opening in balance (meaning within the boundaries of the established value area or range of the preceeding day's trading). During this Typical day the given market may test the boundaries of the established range, but price is driven back towards the value area. Prices at which trading occurs in many given time periods are interpreted as the most fair and equitable prices (green and red lines on left), while prices that are visited during one time period (with price being driven back toward value) are interpreted as less fair price, with an advantage to either buyer or seller based on all current information (highest K prints, lowest D prints on left).
The term range extension is used to imply price movement beyond the confines of an established trading range.
Some traders use the first two time periods of a trading session as a marker to establish the initial balance. The idea is that the two time periods allow enough time for traders to establish the high and low of a fair value area based on all current information (such as overnight news, etc. ). In years prior this range was likely much more important than it is in today's world of 24 hour trading. Nonetheless, this initial balance or any balance area can give reference levels to a trader watching the market. Once price ventures beyond those levels the trader will watch closely to determine how the market reacts to this move. Acceptance and higher or lower price might indicate a change, whereas rejection forcing price back to value would suggest otherwise. The movement of price levels beyond a range bound area is known as range extension. Using Market profile charting this is easily recognized by prints of a given time period moving beyond the limits of the previous periods.
THE CHART ABOVE SHOWS FOUR DAYS IN BALANCE WITH THE VALUE AREAS OVERLAPPING AND THE POINT OF CONTROL (GREEN) QUITE SIMILAR.
Often the market will remain in balance over a given period of time as investors wait on more information before making investments. One of my favorite trades is when the market remains in balance and then breaks from this balance area either higher or lower. The trade of course, is to go with the break once sufficient time and volume have confirmed that the move likely will persist and not be rejected. Balance areas can be clearly and quickly recognized in Profile Charting on various timeframes (daily, weekly, monthly, etc.)
Often, the market under consideration will open
Though markets most typically trade in a balanced fashion (or within a range bound area), to a lesser extent those ranges are sometimes violated, and price moves higher or lower. There are numerous reasons why this may occur with new information likely the most important. As price moves beyond the boundaries of an established range three things can happen:
If circumstances allow, price may continue to move in the one direction, with only minor intermittent retreats, throughout the trading day. This is known as a trend day. Profile charting can help a trader recognize a trend day for being just that. Prices visited in each successive period may overlap the prior period, but the trend is clear, with each successive time period exhibiting new highs (on trend up days) or lows (on down days), and this continues through the close. During a trend down day for example, a trader would expect to see prices in F period reach lower lows than in E period, and prices in L period reach lower lows than K period (see above chart). As any experienced trader would expect, there are some anomalies, and prices in one time period may not go lower than the prior, and may even test and reach a slightly higher high than the previous period, but the expectation would be to see only minor tests on the up side during a down trend. When the market exhibits this behavior the profile chart is said to show timeframing as in the chart above in periods "D" through "N".
It is worth mentioning some Profile Charting vendors here.