Market Profile does not provide buy/sell recommendations, but organizes data in a more readily understandable format in order to illustrate what is perceived as fair value. After you become familiar with the data, you can identify price targets for shorter term moves.
Market Profile was developed in the 1980’s by J. Peter Steidlmayer in conjunction with the Chicago Board of Trade. It is helpful in gaining an understanding of the movement of the market. It does not provide buy/sell recommendations but it does organize data in a more readily understandable format. It can show you whether bears or bulls are in charge of the market, the direction of price moves up or down, and clearly illustrate what is perceived as fair value.
Market Profile is based on the concept that markets have a type of organization which is determined by price, volume and time. Each day, the market develops a range for the value area, which is a point of equilibrium where the number of buyers and sellers is equal. Prices do not stagnate but are constantly diverging and the Market Profile chart records this activity. You can see where the direction of prices is in relation to values. Looking at a Market Profile chart will show you the price range where most trades are occurring. This is called the value area.
Prices may test the upper or lower boundaries but if either range doesn’t attract buyers or sellers, they will tend to fall back into the value area. If prices start to move above the area of value and trading activity continues or increases, it indicates that market participants are re-evaluating value. A higher level of activity with gradually increasing prices may indicate that the support level is also moving up. Support level is established as the lowest price for a stock and activity does not fall below it unless there is a new downward trend. A move upward in the support level may be an indication that demand is increasing and traders are willing to pay a higher price. These trendlines can be seen on the chart and if they continue, new value in prices is perceived and a new region of balance or value is established. By studying these trendlines, you can get a better idea of who is controlling the market and determine which way it is most likely to move.
Market Profile can be used at different increments of time and can be studied at 30 minute increments, for week-long periods, or for times as lengthy as a month. After you become familiar with the charts, you can often spot ‘breakouts’, which may occur at a shorter time frame but which can be reviewed over a longer term market period. Knowing where value is located on the longer timeframe helps you identify price targets for shorter term moves.
Market Profile can be quite helpful to both the day trader and the long term investor. Understanding volume in relationship to activity is the key to understanding Market Profile. If prices start to move away from the area of value but volume starts to dry up, it is likely that the prices will move back to the value area. This indicates that sellers are not pleased with prices that are below value and buyers are not happy with prices that have moved above value.