AN INTRODUCTION TO THE VOLUME PROFILE

In recent years the volume profile has become a popular and fundamental tool for order flow traders. This article explains its terms, characteristics and ways of interpreting the different volume shapes.

The volume profile is created in real time in the course of a trading day and illustrates the traded volume in vertical bars per price level. That way, it indicates dominant and less dominant price levels.

Elements of the volume profile are the volume point of control (VPOC) and the value area. The VPOC illustrates the price level where most contracts have been traded that trading day and, thus, can be called the “fair value”. The value area represents the area where 70% of the daily volume has been traded, the VAH illustrates the upper border, the VAL represents the lower border.

In range phases, prices below the VAH can be considered cheap whereas prices above the VAH can be considered expensive.

Since the volume profile is created in real time, it changes over a trading day. Longer bars illustrate levels where more contracts have been traded and are, therefore, called high-volume nodes or high-volume areas. Shorter bars indicate less traded volume and are, therefore, called low-volume nodes or low volume areas.

Volume Profile. This figure shows a candle stick chart, related volume profile and their terms (extract from 21.08.2019, HG, M15). The figure has been created with Sierra Chart utilising the Sierra Chart study collection.

High volume areas represent levels of interest, respectively price levels that are accepted by the market participants and, therefore, HVNs are preferred trading targets. On the contrary, low volume areas represent levels of no interest, respectively, price levels that are not accepted by the market participants. Therefore, LVNs illustrate support and resistance areas.

Volume Profile Shapes

In the course of a trading day the volume profile is formed with regards to the market participants trading behaviour. The profile’s form can give an indication of the markets sentiments and can be interpreted with regards to the actual form. The emerging patterns are divided into four different shapes:

• D-shape

• b-shape

• P-shape

• B-shape

D-Shape

In course of a consolidation or sideways range, the market forms a D-shape which has the form of a normal distribution. A range will sooner or later be left to the up or downside, therefore, this constellation can be used for breakout trades at the respective range levels.

D-Shape Volume Profile. This figure illustrates a candle stick chart and illustrates the volume profile in a D-shape (extract from 06.09.2019, HG, M15). The figure has been created with Sierra Chart utilising the Sierra Chart study collection.

b-Shape

When the market has fallen sharply and, subsequently, consolidates a b-shape arises. A b-shape prefers entries on the short side and, consequently, such consolidation phases can be utilised to enter the market in the short direction at the value area high level.

b-Shape Volume Profile. This figure illustrates a candle stick chart and illustrates the volume profile in a b-shape (extract from 14.08.2019, HG, M15). The figure has been created with Sierra Chart utilising the Sierra Chart study collection.

p-Shape

When the market has risen sharply and, subsequently, consolidates a p-shape arises. A p-shape prefers entries on the long side and, consequently, such consolidation phases can be utilised to enter the market in the long direction at the value area low level.

p-Shape Volume Profile. This figure shows a candle stick chart and illustrates the volume profile in a p-shape (extract from 06.08.2019, HG, M15). The figure has been created with Sierra Chart utilising the Sierra Chart study collection.

B-Shape

The B-shape is a sequence of D-shapes and represents a continuation of a trend. Even though a chart has, from a mathematical perspective, only one value area and VPOC, however, in a B-shape both “D-areas” can be considered as separate VAs whereof the one with the actual VPOC is the more dominant one.

B-Shape Volume Profile. This figure shows a candle stick chart and illustrates the volume profile in a B-shape (extract from 08.08.2019, HG, M15). The figure has been created with Sierra Chart utilising the Sierra Chart study collection.

Conclusion

The volume profile is built in real time and provides an essential overview about relevant levels and zones. In addition, it greatly helps in determining the actual market context which represents a key factor in successful day trading. 

Despite the named advantages, the use of the volume profile, like any other tool, is limited and its successful use depends on the trader’s skill and experience. Also, in order to receive the gratest value form that tool it must be combined with complementary tools such as the candle stick chart or order flow chart. However, when used correctly and in combination with supplementary tools it represents an essential tool for successful trading.

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