If you recall, we use an average of the closing prices to determine the reference value from our auction. Most of you will think: " I´ve seen this before, same concept as the moving average I use in my trading". Not quite the same. Take a look at the picture below and we will talk about.
So what we did in our example was to use an average of prices to find the reference point, but in fact, value is determined by price x time x volume. The longer time stay at a certain price and the more volume is done at that price, the closer value will be to that price. We´ve come up with that conclusion in our previous articles.
You will now be introduced to Market Profile. What it does is to organize the information obtained by the auction process in a way that we can understand and measure price x time x volume. Once data is organized this way, a normal distribution of prices structure appears. The fun part is, you can apply the same concepts of a normal distribution into this data to make sense of it.
By using the normal distribution, you can define what is value. I use 70% of it´ss area because this is the default parameter used when Market Profile was created. This is why you don´t need to know the reasons of different plays have to buy something to determine value. You determine value by watching what prices they are willing to pay and organizing it in a way you can understand it.
It is now easier to see when prices are expensive or cheap, in relation to value. You probably asking yourself: why the heck is this information useful? Remember what a good deal is? To buy something that is lower than it´s current value (cheap) or to sell something higher (expensive) and buy it back when it comes back to value?
The best trading opportunities will come when prices are between the High and Value Area High or the Low and the Value Area Low. Also you can understand who is in control of the market. Long Term Buyers, Short Term Sellers and so on. All these concepts will be explored in further articles.The Point of Control (or POC) is the fairest value you can pay for some at that time.
For now put yourself into the position of our auction players. If you are a Normal Person or the Artist Fan, you want to buy something for it´s value. If you are a Retailer you do not want to buy something expensive, cause you will not make a profit on it, so you want to buy it for a cheaper price and sell it at least for it´s value. The Collector doesn´t care much about the current value. It just cares about having the item. In the stock market, the Collector does not care much about the value, cause he expects the value to increase a lot over time.
You can say that prices don´t behave only like that and it is true. This only happens when the market is in balance, which means that all the players agree upon value at that point in time. When prices move outside of a normal distribution curve, market starts to trend and will move up (or down) until it finds another area where value will be accepted (price discovery) and the cycle repeats.
There is a lot of things and concepts you can study from organizing the data this way, things a candlestick will not provide you. From now on we will start using charts to show all these concepts and things might become more clear.
If you are in a hurry you can start by looking at one of our daily preparation blogs and you will see the areas and the point of control.
Be patient cause this is just the beginning.
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