In an attempt to determine and evaluate the market value as it developed during the span of a day, and to understand how various market conditions can be assessed using price, time and volume, trader of the Chicago Board of Trade, J. Peter Steidlmayer, devised the concept of Market Profile.
The intra-day charting technique is not a predictive model, nor a technical indicator. It is simply a graphic way in which to organize existing data by displaying price on a vertical axis and comparing it across time on the horizontal axis. The result is typically a bell-shaped graphic that is wider at the middle prices and volume diminished at the extreme lower and higher prices. While the graphic is not predictive in any way, it does allow investors to determine points of stability and possible future price moves based on the past behavior of an asset. By showing the price distribution during a specific time period, market profile allows investors to understand at which price range an asset has spent the most time and to determine support and resistance levels.
Throughout the day, orders to buy and sell financial instruments are placed, establishing a value area, which represents the balance between demand and supply. This supply and demand forces form a normal distribution curve, which changes and moves towards different value areas depending on the volume traded at one time or another.
To understand the importance of market profile, it is important to follow the moves from one value area to the next. Here’s how to read a market profile chart:
- TPO (Time-Price Opportunity): the key element unit of a market profile graph is TPO. It shows each time trading of an asset touched a certain price during the day. TPO is typically represented in 30 minute spans and displayed on the chart using either letters or colors.
- Price and profile distribution: the vertical axis of a market profile chart displays the price of an asset, whereas the horizontal axis displays both volume and date. You can either see a day’s profile distribution, which is a market profile chart for a given day, or you can see a range of dates.
- Volume: each day, market profile charts show distribution of price and volume with bars extending horizontally along the X axis. Within the trading day however, the chart’s horizontal bar shows volume, not time. The longer the bar is at a certain price point, the longer it traded at that price.
- “O” and “#”: the letter “O” on a market profile chart shows the opening price for the day, while “#” shows the closing price.
Market profile offers you many advantages that other charts don’t:
- It provides you with a clear view of market activity in real time. It allows you to see what is happening, when it’s happening. If you can clearly see what is happening in the present, you may be able to make better and more informed decisions about what might happen in the future.
- It forces you to understand how the market works. If you rely solely on signals or indicators, you’ll always trade in the dark, relying on these to set up trades. A side effect of you learning how to read a market profile chart is that you will inevitably gain a better understanding of the market and how it works, leading you to make better and more informed decisions based on analysis and judgement.
- The best trading decisions you can make are based on your perceived value of an asset. Market profile charts enable you to determine where the value is in the market so that you are able to make better decisions.