How to Draw a Market Profile - dummies

How to Draw a Market Profile

Structural theories — a category of technical analysis — include the broadest measures of market behavior, like seasonality. The most inclusive of the structural theories is market profile.

Each crowd, whether a fraternity or a gang, develops criteria for normal behavior. The secret vocabulary of traders in a specific security or class of securities takes the form of prices changing by a certain amount over a period of time (usually one day, one week, and one month). The crowd that trades a specific security, for example, knows that the average daily range of prices between the high and low of the day is normally some specific amount.

Market profile is a technique for analyzing the normal behavior of the crowd while in the process of trading a security. Using a fictitious security, the following figure shows trading during a particular day. Each X stands for blocks of shares traded.

All the Xs add up to the volume figure for the day — the number of shares or contracts traded, as reported by the exchange. The number of shares or contracts is recorded according to the price associated with them and the time of day the transactions took place.

A market profile that shows trading for a particular day.
A market profile that shows trading for a particular day.

As you can see, the price ranged from $8 (the low) to $11 (the high) on that day, with the average price at $9.50. (In this instance, the arithmetic average is the same thing as the mode, which is the price that occurs most frequently. This isn’t always the case, and if you pursue this method of looking at markets, you’ll have to deal with situations where the average differs from the mode.)

Turn the page sideways. Do you see the outline of a shape in this price distribution? If you’ve ever sat through a statistics class, you may be able to pick out the bell-shaped normal distribution curve. It’s called a normal distribution because you can use it to describe a set of data that varies around an average value.