Volume Profile Strategies
The stock market is an ever-changing landscape, and traders are constantly looking for new ways to gain an edge. One technique that has gained popularity in recent years is the use of the volume profile. In this article, we will explore what the volume profile is, how to read it, and how to use it to make informed trading decisions. We will also discuss the advantages and limitations of the volume profile.
What Is Volume Profile?
A volume profile, depicted by a volume-by-price (VbP) chart, is a trading indicator that displays the total volume traded at each price level over a specified period of time. The volume profile may be based on the visible range, which is the period of time that is currently visible on the chart. It may also be based on a custom range set by the trader, the session range, etc.
Compared with the more well-known volume-by-time indicator, which is the measure of trading activity over a specific period of time, the volume profile provides a more detailed view of trading activity at each price level. It can be a valuable tool for traders looking to identify key levels of support and resistance, confirm trends, and plan entry and exit points.
How to Read a Volume-by-Price (VbP) Chart
The volume profile is usually displayed as a horizontal histogram or bar chart, a VbP chart, that appears along the y-axis. The length of each bar represents the volume of trades that occurred at each price level during a specific range of time, with longer bars indicating higher volume and shorter bars indicating lower volume.
The range of time the volume profile is measured from can differ depending on the goals and preferences of the trader. The most commonly used range of time is Volume Profile for Visible Range (VPVR), which is the range of time that is currently visible on the screen. This volume profile measurement is the default and sometimes the only choice for some trading platforms. It’s not ideal because you have to be precise with your zooming and the volume profile changes whenever you zoom in or out.
TrendSpider allows traders to manually or automatically select a point in time to measure the volume profile from in what is called the Anchored Volume-by-Price (AVbP). Additionally, TrendSpider and some other trading platforms allow traders to select what is called a Measured Volume Profile, in which traders select a full range, or both the start and end points for the volume profile measurement. Either of these options gives traders the ability to glean more meaningful data from the volume profile.
Here are some other key components of a Volume-by-Price chart:
- Low Volume Node: A low volume node is a price level within the chart that has a low volume of trades. It represents a level of less interest to traders, where there is a lack of buying and selling activity.
- High Volume Node: A high volume node is a price level within the chart that has a high volume of trades. It represents a level of significant interest to traders, where there is a lot of buying and selling activity.
- Point of Control (PoC): The point of control is the price level within the chart with the highest traded volume. It represents the most significant price level of interest to traders, where there is the most buying and selling activity.
- Value Area: The value area is the range of price levels within the chart where a specified percentage of the total traded volume occurred. The most common percentage used is 70%, but this can vary depending on the trader’s preference. The value area is typically shaded on the chart and is used by traders to identify significant price levels of interest, such as support and resistance levels.
Additionally, the bars may be displayed with two colors representing buying volume and selling volume. Green or white usually indicates buying volume and red or black usually indicates selling volume, however, colors may vary depending on a trader’s software or customizations.
Volume Profile Strategies
Here are some ways that traders can use the volume profile in their trading strategy:
Identify volume shelves
Volume shelves are areas of the chart where the volume of trading activity has been concentrated at a particular price level or range of price levels. They are called “shelves” because the visual representation of the volume in these areas creates a shelf-like appearance on the VbP chart.
Traders use volume shelves to gain insights into supply and demand dynamics in the market. When the volume shelf is long and has a high volume of trades, it can suggest a market where buyers and sellers are in agreement on the price level, indicating a balance between supply and demand.
On the other hand, a shorter volume shelf or a volume shelf with low volume can indicate that the market is less liquid or that buyers and sellers are less in agreement, indicating an imbalance between supply and demand. These areas of low volume create “volume gaps” and prices can move very quickly through them to the next volume shelf.
In addition to identifying supply and demand imbalances, traders may also use volume shelves to identify potential support and resistance levels. For example, a volume shelf that is longer at a certain price level may indicate that a large number of buyers or sellers are active at that level, potentially creating a support or resistance level for the asset in question.
Analyze different timeframes
Analyzing different timeframes in relation to the volume profile can provide traders with a more comprehensive view of market activity and help them to identify trends and potential trading opportunities.
For example, looking at the VbP chart on a daily timeframe can help traders to identify long-term trends and potential support and resistance levels. By looking at the VbP chart on a 60-minute or 10-minute timeframe, traders can gain more detailed information about short-term trends and price movements.
Analyzing the volume profile on different timeframes can also help traders to confirm or invalidate trading signals. For example, if a trader sees a potential support level on the daily chart and a corresponding increase in trading volume, they may want to look at the 60-minute or 10-minute chart to confirm that there is a corresponding increase in trading volume at that level on shorter timeframes.
Additionally, analyzing the volume profile on different timeframes can help traders to identify potential entry and exit points for their trades. For example, if a trader sees a potential support level on the daily chart and a corresponding increase in trading volume, they may look at the 60-minute or 10-minute chart to identify an optimal entry point with a lower risk profile.
Analyze different ranges
Analyzing the volume profiles of different ranges can provide traders with a more detailed view of market activity and help them to identify important price levels and trading opportunities. Here are some common types of ranges that traders may analyze:
- Visible range: This is the range of time that is currently visible on the screen. Analyzing the visible range can provide traders with a broad view of the market and help them to identify long-term trends and potential support and resistance levels.
- Session range: This is the range of time during a specific trading session, such as the regular trading hours for a particular exchange. Analyzing the session range can help traders to identify price levels that are particularly relevant to that trading session, such as intraday support and resistance levels.
- Custom range: Traders may also choose to analyze a specific range of time, such as from a recent swing high or low. Analyzing a custom range, like with TrendSpider’s Anchored Volume-by-Price, can provide traders with more focused insights into market activity and help them to identify potential entry and exit points for their trades.
Analyzing the volume profiles of different ranges can help traders to make more informed trading decisions.
Use volume profile with other indicators
Using the volume profile in conjunction with other indicators can provide traders with a more comprehensive view of market activity and help them to identify potential trading opportunities. Here are a few ways that traders may use the volume profile in combination with other indicators:
- Technical indicators: Traders may use technical indicators such as moving averages, trend lines, or oscillators in conjunction with the volume profile to confirm or invalidate trading signals. For example, if the volume profile indicates a potential support level, a trader may look at a moving average to confirm that the price is trending upward.
- Price action analysis: Traders may use price action analysis techniques such as candlestick patterns or chart patterns in conjunction with the volume profile to identify potential entry and exit points for their trades. For example, a trader may look for a bullish candlestick pattern and a corresponding increase in trading volume to confirm a potential support level.
- Fundamental analysis: Traders may use fundamental analysis techniques such as earnings reports or economic data in conjunction with the volume profile to identify potential trading opportunities. For example, if an earnings report indicates strong sales growth for a company, a trader may look for a corresponding increase in trading volume to confirm a potential buying opportunity.
By using the volume profile in conjunction with other indicators, traders can gain a more comprehensive view of market activity and identify potential trading opportunities with greater accuracy. However, it is important to use multiple indicators in a balanced and rational manner, as no single indicator can provide a complete picture of market activity.
Volume Profile Pros and Cons
Here are some potential pros and cons of using the volume profile in a trading strategy:
- Provides insight into market activity: The volume profile allows traders to see how much trading activity is taking place at different price levels, providing valuable insights into market activity and potential support and resistance levels.
- Helps identify potential trading opportunities: By analyzing the volume profile, traders can identify potential trading opportunities based on key price levels and trading activity.
- Customizable: The volume profile is highly customizable, allowing traders to select different timeframes, ranges, and other settings to fit their trading strategies.
- Can be subjective: The interpretation of the volume profile can be subjective, as different traders may see different patterns or levels of importance in the data.
- May not work in all market conditions: The volume profile may not work as well in markets with low trading volume, as there may be less reliable data to analyze.
- Limited historical data: The volume profile only provides data for the selected timeframe and range, so traders may not have access to historical data beyond that period.
Overall, the volume profile can be a valuable tool for traders, but it is important to use it in conjunction with other indicators and to be aware of its potential limitations.
Example scanner based on Volume Profile
The Bottom Line
In conclusion, volume profile is a powerful tool for traders looking to gain insights into the market dynamics of a particular security. By analyzing the volume of trades at different price levels, traders can identify areas of interest and potential support and resistance levels. With proper risk management and a solid trading plan, volume profile can be a powerful tool for traders looking to improve their trading performance.