Using Bell Curves to Spot Market Trends

Trend and consolidate, run and rest, trend and chop are expressions often used to describe the two things markets do. They move from balance to imbalance and back. Different strategies are employed during a trend cycle vs. a consolidation phase. When a market is trending, there tends to be very little overlap in prices from day to day. Conversely, prices often overlap severely during a consolidation phase.

Before markets begin to trend, they frequently establish balance areas. Such areas form when there is a series of consecutive days with below average ranges that are similar and thus overlap; plus volume is often below average.

The crude oil chart below illustrates this point. The colored boxes reveal value areas. Value areas contain approximately 70% of the volume during regular trading hours, which is the highest volume or most liquid time of day. When value areas severely overlap for a week or more, a trend or breakout often ensues.

Identifying the onset of a trend may be enhanced if one can establish when a market has found balance or completed a consolidation phase. There is a charting method that organizes price action into structures that measure the maturity of a consolidation period. Gaussian or normal distributions are also known as bell curve. Market profile or macrograph are industry terms for this charting method.

When a bell curve or normal distribution takes shape over a week or more, it is often an indication that a trend is about to begin. The macrograph below shows the same crude oil chart as the one above but in structures that display a fair value or balance area. These bell curves form by plotting time at price. The more time spent at price, the more volume accumulates. The point that sticks out the furthest is the fairest or high-volume price.

Note that just before the rally (week of 6/17) and the decline (7/8) began, a normal distribution or balance profile took shape. When timing breakouts, search for markets that have found balance and have a well-defined high-volume price. Normal distributions frequently form before and after trends.

John Seguin
Senior Futures Instructor
Market Taker Mentoring, Inc.

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