MarketProfileTM can be used to determine the frequency and volume that a particular level was transacted at in the foreign exchange spot market. It was pioneered by J. Peter Steidlmayer and the Chicago Board of Trade (now part of the CME Group) in the 1980's, and is based upon auction market theory. It organises data such that a market participant can gain an in depth understanding of price action, identify what the perceived fair value of the market might be, and locate key support and resistance levels, all by representing the volume distribution either against a price scale or a time distribution against a price scale.
Picture a perfect, normal distribution curve, which looks like a bell shape - the highest point of the distribution is the median, mean and mode. If using our preferred volume distribution against price, the high point of the curve is the price point that attracted the most interest (i.e. volume) during a trading period, and is known as the "Point of Control" or PoC. A "Naked PoC" or nPoC is a previously established PoC, whose ValueArea does not overlap with recent ValueArea's, and is outside today's ValueArea - it can act as a key level of support or resistance.
The ValueArea is depicted by trimming 15% from the bottom and top of the distribution (i.e. where 70% of trades takes place, which roughly represents 1 standard deviation). The upper level is called the "ValueArea High" or VaH, and the lower level is called the "ValueArea Low" or VaL. These levels also act as key levels of support and resistance. N.B. by identifying the 15th & 85th percentile levels of the distribution, a distribution does not necessarily need to follow a normal distribution (e.g. distributions that are skewed to the left or right) - if one standard deviation extremity levels were adopted, a skewed distribution may provide a false depiction of ValueArea. For PoC, we adopt the mode. Care needs to be taken in the event that there are multiple distributions, i.e. identification of each PoC and ValueArea's.
We also measure bigger picture PoC's - over a weekly timeframe, with a weekly PoC "wPoC" flagged if it also has a significant volume wall before or after the level.
A Pothole represents a level in the middle area of a price distribution that represents little or no interest from market participants. They counter-intuitively can act as a key level of support or resistance.
ValueArea is not an indicator - it is merely a decision support tool, albeit a very important one that is used by many successful investors, traders & insititutions under different guises.
The distribution below depicts that the mode of the distribution is 1.6113 (our PoC), the 15th percentile is also 1.6113 (our VaL), and the 85th percentile is 1.6137 (our VaH). However, you could also argue that there are 2 distributions, the first one with a PoC of 1.6136, and the second one with a PoC of 1.6113.
PRICE VOLUME Volume Plot x = 20
1.6143 86 xxxx
1.6142 50 xxx
1.6141 228 xxxxxxxxxxx
1.6140 194 xxxxxxxxx
1.6139 308 xxxxxxxxxxxxxxxx
1.6138 842 xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx
1.6137 548 xxxxxxxxxxxxxxxxxxxxxxxx
1.6136 1022 xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx
1.6135 384 xxxxxxxxxxxxxxxxxx
1.6134 334 xxxxxxxxxxxxxxxxx
1.6133 496 xxxxxxxxxxxxxxxxxxxxxxxxx
1.6132 684 xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx
1.6131 468 xxxxxxxxxxxxxxxxxxxxxxx
1.6130 836 xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx
1.6129 794 xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx
1.6128 520 xxxxxxxxxxxxxxxxxxxxxxxxx
1.6127 240 xxxxxxxxxxxx
1.6126 252 xxxxxxxxxxxxx
1.6125 122 xxxxxx
1.6124 214 xxxxxxxxxxx
1.6123 52 xxx
1.6122 28 x
1.6121 366 xxxxxxxxxxxxxxxxxx
1.6120 124 xxxxxx
1.6119 16 x
1.6118 112 xxxxxx
1.6117 322 xxxxxxxxxxxxxxxx
1.6116 126 xxxxxx
1.6115 402 xxxxxxxxxxxxxxxxxxxx
1.6114 326 xxxxxxxxxxxxxxxx
1.6113 1286 xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx.....xxxxxx
1.6112 576 xxxxxxxxxxxxxxxxxxxxxxxxxxxxx
1.6111 260 xxxxxxxxxxxxx
1.6110 72 xxxx
1.6109 78 xxxx
1.6108 56 xxx
1.6107 16 x
1.6106 4 x
Another way of thinking about ValueArea is the concepts of balance, and responsive activity vs initiative activity ...
Balanced Markets – trading within the ValueArea
The basic significance of a market trading within ValueArea is that of a balanced market. It shows buyers and sellers are equally matched and facilitating trade at mutually agreeable prices. Price will wander but when it reaches the VaH or VaL, responsive activity (see below) is often present, driven by institutional traders.
Out of Balance Market – Trading outside the Value Area
The basic significance of a market trading outside the ValueArea is that of an out of balance market in which the ValueArea is being rejected. When the market is above or below the ValueArea it is showing us that either the longs or shorts are currently attempting to influence the market. A key observation is when the market opens out of balance and begins to randomly trade back and forth but still stay outside the previous day’s ValueArea. Essentially you are witnessing a market build value outside the previous day’s ValueArea which would confirm an out of balance market.
This is when a market opens above or below the ValueArea and stays outside of it. If opening above the ValueArea it shows traders are “initiating” trading above known value and higher prices are expected. If opening below the ValueArea it signifies traders are “initiating” trading below known value and lower prices are expected.
Initiative Buying - When the market opens and stays above the ValueArea it should be viewed as a strong bullish signal and moves higher should not be faded. Many times this type of trading activity is a result of institutional traders who have lots of buying to do and are able to support prices for the trading day. Fighting this type of move can be gruelling and very unprofitable. “The trend is your friend” is very true when initiative buying is present. Knowing and understanding the ValueArea can really help keep you on the right side of the market and from getting run over by a strong bull market. The best strategy for a day exhibiting initiative buying is to buy pullbacks until proven wrong. Sustained probes back into the ValueArea should be viewed cautiously as the market may be showing signs of weakening.
Initiative Selling - When the market opens and stays below the ValueArea it should be viewed as a strong bearish signal and moves lower should not be faded. Many times this type of trading is a result of institutional traders who have lots of selling to do and will be pressuring prices for the trading day. Fighting this type of move can be gruelling and very unprofitable. Identifying initiative selling by realising where the current market is trading in relation to the ValueArea can really help keep you on the right side of the market and from getting run over by a strong bear market. The best strategy on a day exhibiting initiative selling is to sell bounces until proven wrong. Sustained probes back into the ValueArea should be viewed cautiously as the market may be showing signs of strengthening.
This is when price trades outside the ValueArea and is met with an opposite response and rejected back into the ValueArea. This type of activity is often present when a market is trading within the ValueArea and makes an attempt to trade outside of it.
Responsive Buying – There are a couple of scenarios that could be classified as responsive buying.
The first scenario occurs when the market opens within the ValueArea and makes an attempt to trade below the ValueArea. Buyers enter the market and auction price back into the ValueArea. This shows responsive buyers stepping into a market that is trading below value and taking advantage of the low prices. This strategy works well in ranging (sideways) markets.
The second scenario occurs when the market opens below the ValueArea and buyers immediately start entering into the market. This would be witnessed by prices moving higher from the open as buyers “respond” to price below value. A good initial target would be VaL. When this type of responsive buying occurs it is likely that the 80% rule would come into play. The 80% Rule is a simple, yet powerful ValueArea trading strategy which was first mentioned in The Profile Reports (Dalton Capital Management 1987 - 1991). It stated that there is an 80% chance when a market opens (or trades) above or below the ValueArea, and then trades in the ValueArea for two consecutive half hour periods, then the market has an 80% chance of filling the entire ValueArea.
Responsive Selling – There are a couple of scenarios that could be classified as responsive selling.
The first scenario occurs when the market opens within the ValueArea and makes an attempt to trade above the ValueArea. Sellers enter the market and auction price back into the ValueArea. This shows responsive sellers stepping into a market trading above value and taking advantage of the high prices. This strategy works well in ranging (sideways) markets.
The second scenario occurs when the market opens above the ValueArea and sellers immediately start entering into the market. This would be witnessed by prices moving lower right from the open as sellers “respond” to price above value. A good initial target would be VaH. When this type of responsive selling occurs it is likely that the 80% rule would come into play.
Always remember that trading derivatives on margin carries a HIGH LEVEL OF RISK
, and may not be suitable for all investors. Before deciding to trade derivatives you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with derivatives trading, and seek advice from an independent financial advisor if you have any doubts.