Many traders use technical indicators to analyze past and predict future price movement, and to identify potential trade entry and exit points. Technical indicators are mathematical calculations derived from price or volume activity. A moving average, for example, calculates the average price of a specific instrument over a defined number of time periods. Often traders will compare moving averages from various time frames to determine market momentum.
In addition to (or instead of) technical indicators, traders can view price and volume action that are untouched by mathematical calculations. One method of analyzing this market information is through Volume Profile, an advanced charting study that displays trading activity for each price level over a specified time.
Here, we discuss Volume Profile, explain key concepts and look at the different profile types that emerge throughout a trading session. In a second part, we’ll expand on this introduction to explain how Volume Profile can be used to spot high-probability trading opportunities.
Histogram vs. profile
Most traders are accustomed to viewing volume as a histogram that appears across the x-axis (or bottom) of a price chart (see “Volume histogram,” below). A volume histogram examines volume over the time scale and tells us how much trading activity occurred during each specific period, be it daily, five-minute, 610-tick, or 2,000-volume price bars. This way of interpreting tells us when volume occurred, but offers no clues about where it took place.
A different way to view volume is with a Volume Profile chart study. Volume Profile was first used by futures traders using data that was available only to floor traders at the futures exchanges. With today’s advanced charting platforms, virtually any trader can access this type of market analysis to identify where (price) trading activity took place and how much (volume) trading took place at each price level.
Volume Profile appears as a price chart overlay (meaning it is drawn directly over a price chart), and it displays the total accumulated volume at each price level. Unlike a traditional volume histogram that appears across the time scale, Volume Profile appears along the y-axis, over the price scale of a price chart.
“Volume profile” (below) shows one type of Volume Profile study applied to a 5-minute chart of the E-mini Standard & Poors 500 futures contract (ES). Each horizontal bar in the Volume Profile represents one price level—such as 2005.25 or 2008.75—as we see on this E-mini S&P 500 chart. Each bar indicates how much trading activity has occurred at that particular level and up until that point of the trading session.
Navigating volume profile
Several noteworthy elements are found within a Volume Profile study, as shown in “Volume profile breakdown” (below):
Current Price: The most recently traded price (in the chart, the yellow bar).
Point of Control (POC): The price level with the largest traded volume (the red bar).
Value Area: A range of prices in which a specified percentage of all volume was traded.
High Volume Nodes (HVN): A peak in volume at or around a price level.
Low Volume Nodes (LVN): A valley in volume at or around a price level.
The Point of Control (PoC) is the single price that has accumulated the most volume so far in the trading session. The PoC often acts like a magnet, and prices that move above or below the PoC often return to it again and again throughout the trading session. The PoC can stay at one price level the entire trading session or it can move, depending on where trading is taking place. In an actively traded market like the E-mini S&P, the PoC might move two to three times throughout the regular trading session.
The Value Area is the range of price levels where a specified percentage of the session’s trading took place. Typically, this is set to one standard deviation (68%) of overall volume. The Value Area can be thought of as the “fair” price range where traders see the most value and where the majority of trading occurs.
Volume Profile illustrates that certain prices attract lots of volume, while others experience much less activity. High Value Nodes (HVNs), which appear as peaks on Volume Profile, occur where the most significant intraday trading has taken place, reflecting the most popular and accepted prices among market participants during the trading session. The valleys of the volume profile are known as Low Volume Nodes (LVNs). LVNs are price levels where less trading occurred, and can be thought of as prices that were generally rejected by market participants. Typically, multiple HVNs and LVNs emerge on a single chart throughout the trading session.
Dynamic patterns
Volume Profile is dynamic in nature and changes constantly throughout the session. It’s not like looking at a regular x-axis volume histogram where, once the volume bar has printed, it remains unchanged for the rest of the day. Volume Profile bars update to reflect current trading activity.
The individual bars never get shorter because that volume has already occurred, but any bar can get longer with more volume at a particular price level, and an increased number of bars can print as higher or lower price levels are reached. As the bars change, different patterns emerge within the Volume Profile that can provide clues about where the market is headed. Patterns (see “Profile patterns,” below) might include:
“P” pattern signifies an uptrending market
“b” pattern shows a downtrending market
“D” pattern is indicative of a consolidating market
“Zig-zag” pattern represents a non-directional, developing market
Volume profile vs. Market depth
It may be helpful to note the distinction between Volume Profile and Market Depth, another popular chart study that is often used in conjunction with volume profile. Where Volume Profile displays actual trading activity that has already happened in the market, Market Depth shows the buy and sell orders that are lined up at this point in time. Market Depth provides real-time information about the prices at which traders are willing to buy and sell, but it does not represent the trading activity that actually takes place; instead, it shows what might take place.
Volume Profile is a charting study that answers two questions about volume: where and how much? In addition to showing the aggregate volume at each price level, Volume Profile shows the price levels that have been generally accepted by traders, and those that have been rejected. This information can help traders make predictions about future price direction to identify trade entry and exit points.
It shows high traffic areas that often serve as support and resistance levels as well as low traffic areas that should be avoided if a trader attempts to execute size as the market offers little resistance once a level is breached.
In the next installment, we’ll dig deeper into Volume Profile, explain how to trade with it and show trade examples.
Jean Folger is the co-founder of, and system researcher with, PowerZone Trading, LLC. Jean can be reached at jean@powerzonetrading.com.