Auction Market Theory

Let’s take an example of a car that costs twenty-two thousand dollars. We can assume this to be no different than a stock–sellers want to make the most money possible and buyers want to pay the least amount of money possible. Now let's say the price goes up to twenty-five thousand dollars for some unknown reason. Using simple logic, buyers will become more reluctant to buy the car, so less volume will be traded. But the dealership (sellers in this case) is like “wow some people are buying at this price so let's get as much out as we can” and becomes very aggressive. This combination of less aggressive buyers with more aggressive sellers reverts back to the true value of twenty-two thousand dollars. The same can be said if for some reason, such as hardware problems, the price reverts down to nineteen thousand dollars. Now, buyers are the aggressive ones and the sellers are the reluctant ones. This is basic economics.

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If we look at the distribution of the volume of shares being traded, we find that it’s a normal distribution curve if compared on the price axis to the price vs time graph. And if we think about it, it makes sense: higher prices will be traded less and less while lower prices will also be traded less and less due to auction market theory, as explained before.

One tip I have which I use frequently when trading is to use the software TradingView’s anchored volume profile to create these normal curves (on a 1 month chart) to see what prices the public is gravitating towards as true value when deciding if this company is the right investment.