As the market’s two-way auction process unfolds, there is an ongoing search for information between buyers and sellers (much the same way that manufacturers and distributors continually seek information about each other to maximize profits). Once either party perceives an advantage, they will attempt to move price away from fair value in order to increase profit. This attempted divergence is constant, and the market profile records the resulting auctions via a histogram, or distribution curve.
Historically, scientists have employed the histogram to organize data so that it can be observed and better understood. As Peter Bernstein establishes in his book Against the Gods: The Remarkable Story of Risk (New York: John Wiley & Sons, 1998), “The normal curve, or bell curve, enabled the evolution of human civilization” by providing a means of determining, statistically, the potential risk and reward intrinsic in any venture (such as opening a trade route to the West Indies).
A market profile histogram is created through the ongoing development of the market’s information-discovery system—its continuous twoway auction process that advertises price in order to distribute volume in a fair and competitive manner. The volume, or bidding activity, determines whether or not divergences from value can be sustained. On one day, sellers are discouraged by prices below value, and buyers are discouraged by prices above value.
When both sides have essentially established a “value area,” any movement away from value will serve to shut off the flow of auction activity until price returns to equilibrium. This is commonly known as reversion to the mean. On another day, the same market may find that divergences from value—higher or lower prices—actually attract more volume rather than shutting it off, which forces participants to reassess their idea of value (investors who trade via reversion to the mean will be unable to sustain profitability when divergences from value are successful).
We demonstrate how knowledgeable, Profile-experienced traders can perceive both situations while markets are unfolding by observing the Profile’s graphic depiction of the relationship between time, price, and volume—the true fundamentals of market behavior.
In the discussion above, we referred to the day timeframe; however, the same theory applies to all timeframes. While we have not yet described these time frames, we have referred to them as scalpers, day time frames, short-term timeframes, intermediate-term timeframes, and the long-term time frame.
Read More : Fair Value Of Price
