Enhance your Entries with the Volume Profile



With a bearish and oscillating market like the current one, without the artificial support of the Fed as it was for years, it makes little sense today to create a long portfolio until the market defines its course. Then, it's an ideal environment for the retail trader to carry out more intraday operations (day trades) or a few days (swing trades).

It's known that day trading is a task that requires great precision. In this context, there is a very useful tool that can help us improve our intraday entry and exit levels, based solely on the volume of trades executed: the Volume Profile. It's different from other standard indicators that show volume at a specific time: this tool displays it in a histogram, so we have the volume at a specific price

Essentially, the Volume Profile indicator takes the total volume traded at a specific price level during the specified time period and divides the total volume into either buy volume or sell volume, making that information visible to the trader at a glance. Volume at a price gives more useful information as it provides the price levels in which big players' actions took place. You can see at certain price levels, that the volume is very thick: this level indicates the accumulation of massive quantities. Very easy reading and great for identifying support and resistance!

The data that is provided by Volume Profile is indisputable, leaving it to the trader to find creative ways to use it. But is especially powerful when it's configured for a daily session to identify intraday entry points, as well as stop-loss and target levels. Due to its dynamic nature, investors, who buy stocks for the long term, use the Volume Profile over longer periods of time, such as months, quarters, or years, to look for high-value entry levels. And swing traders, configure it for shorter time periods such as weeks, to determine better entry/exit and stop-loss levels. All are valid uses of this flexible tool.

Identify in the chart below, the four main values of a typical Volume Profile histogram: the Point of Control, The Value Area, the High and Low Volume Nodes, and the typical profile distributions. Below is a brief explanation of them and the strategy I use for each one.

Above is shown an $NVDA intraday 5-min chart, with the Volume Profile configured for 1-day, showing its typical histogram, the Value Area, and the levels of significance. 




1. Point of Control (POC), the crucial level


The most crucial price level in any Volume Profile is the Point of Control. Is the price level with the highest traded volume. And mainly, is the level where the big guys start there their positions, so it's an accumulation/distribution level for smart money.


Strategy: The previous POC will serve as an obvious reference point (as support or resistance) for a current trading session and also for the next. So, a popular strategy is to extend it: often a price reaction is there in the next session, as support or resistance, waiting for the first touch on the POC. There are good buying or selling opportunities, due to the previous day's VP shape, as explained later.


As seen above, in the drawing taken from quora.com, in both previous day cases, the Volume Profile shape with the POC near or at the center is called a "normal distribution", one of the typical VP shapes.

Due to the natural laws of statistics and this Gaussian Bell, it's a feature that, in this particular case, the price tends sometime during the next opening session, to approach the extended POC and define there their course, having not achieved it in the previous day. So wait for a violent move in any direction, until the price touch that POC. I
n the drawing above, the POC acts such as support (left case) or resistance (right)


2. Typical Volume Profiles (VP), useful for the next session


While volume profile patterns may initially seem random, there are recurring distributions that can provide insights into the market direction, S/R or reversal levels, and more. The key here is that the shape of the volume profile histogram and the POC level at the end of the session, are both very useful to estimate the likely movement of the price for the next session, depending on who is "controlling" the price action, bulls or bears.

- The D-shaped Distribution: is the same "normal" or bell distribution from the previous example. This distribution indicates that there was a balance or indecision at the end of the session, and it's not known who is in control for the next session, bulls or bears. Traders look for D-shaped volume profiles in anticipation of a potential breakout in either direction as the price is ranging and institutional players build their positions.

The b-shaped distribution: is formed when the price falls sharply and then consolidates, usually as a result of an intraday sell-off. And if appears during an uptrend could mean a potential reversion. Finally, both indicate the strength of the bears before the market finds its balance. 
And if the price closes within its range and near the POC, it reinforces the downtrend for the next day. But, if the price closes far above the POC it is likely to have a choppy session the next day with the bears losing control.

- The P-shaped distribution: the opposite of the b-shaped, occurs when the market rises strongly and then consolidates. VP forms a P-shaped profile, with a later balance between buyers and sellers. P-shaped happens in uptrends and when appears in downtrends could mean the end of it, through a short-covering, both bullish signals. 
And if the price closes within its range and near the POC, it reinforces the uptrend for the next day. But, if the price closes far below the POC it is likely to have a choppy session the next day with the bulls losing control.


As a combination of the three main shapes, the Volume Profile can create two or more areas of value via a noticeable volume accumulation in the histogram. In the majority of cases, we will have the creation of two distributions (sometimes three). This called B-shaped distribution occurs when two D-shaped happen within a session. While B-shaped profiles are generally interpreted as a continuation of a trend, it is important to note which POC is more dominant, separating the profile into 2 separate 'D areas' with their own value areas.




3. Value Area (VA), works as a support/resistance level


Represents the range of price levels in which a specified percentage (typically 70%) of all volume was traded during the time period. Since this value area (and the POC) represent "high gravity" areas where participants have seen the most value, its upper/lower borders can be used as resistance/support levels, respectively. Simple.

Strategy 1: if the price falls outside the VA, search for reversals, waiting for a low trading volume in resistances or a high trading volume for supports. So, depending on your bias:

- You can be long if the current price is below the POC.
- Or short, if the current price is above the POC.

Strategy 2: use the previous VA1 to analyze market behavior (trending or ranging), just extend it, and compare it with the next session's value area (VA2).
- If VA2 is inside the previous VA1, prices tend to range inside it. 
- If there is a gap between VA1 and VA2, it means traders want new prices, so it's a trend day, and it likely will continue.


4. High Volume Node (HVN), acts as a magnet for prices


The High-Volume nodes are peaks in volume at or around a price level and can be seen as an indicator of a period of stability or consolidation. As with the POC, usually, there are a lot of trades (buys and sells) and the market stays there more time than usual in HVN levels, pulling prices as a magnet, over and over throughout the session. HVN are prices where the smart money is trading and often represent key areas of support/resistance. Therefore, stronger S/R levels are aligned with larger HVN and are correlated with swings in price.


Strategy: When the price approaches a previous HVN, a sustained period of sideways movement is expected. The market is less likely to immediately breakthrough that price. So, in a risk-reward strategy, it's a good level to set a target for an exit: as been attractive levels early, traders usually sell there. 

In the same line, when you catch an intraday rally, for example, after a breakout, near HVNs are good places to set (and then trail) the stop-loss, instead of place it at the usual structure swing level. It's a more aggressive place, as it's tighter, but allows you to get a better risk-reward.


5. Low Volume Node (LVN), prices move fast through it


Are the opposite of the HVN. They are valleys (or significant drops) in volume at or around a price level. LVN is usually a result of a breakout rally or a breakdown, so when price approaches a previous LVN, the market is much more likely to rally through or bounce off of that price level.

Strategy: so, by definition, breakouts and pullbacks usually began at an LVN level... or pass it quickly! Depending on your bias, bullish or bearish, try this interesting move:

- For a long trade use a buy stop order in the first LVN level above the price. Place your stop-loss just below an HVN (to avoid getting stopped if the price reaches HVN and goes up). And align your profit-target with another upper HVN.
- For a short trade use a sell stop order in the first LVN level below the price. Place the stop-loss just above an HVN, and the target on another lower HVN.



Finally, use these considerations in your day trading


The $NVDA 5-min chart below resumes my Volume Profile strategies from daily trading. Check carefully and verify how powerful is this tool, undoubtedly one of the best for defining entry and exit intraday levels. Due to its versatility, consider these strategies and also check others.
 

My practical recommendation for the Volume Profile is to use it in a 5-min chart, in conjunction with Price Action Analysis (using major timeframes as the 1-hour, to decide trends, draw trendlines, price patterns, and key areas, as usual) and other few indicators: remember, less is more in technical analysis.

In my case, as explained in recent posts, I use only two: the VWAP for rejections only in a strong uptrend (not shown), and the RSI, for divergences at a key level, then confirmed by price action, with a trendline break and a candlestick confirmation.


It's clear you can use the Volume Profile in any timeframe to get accurate support and resistance levels. For example, set it in a weekly chart brings good levels for a position trade, that's the long-term. But I consider that in a daily chart we can take better advantage of all its features, explain above. I use it in a 5-min chart to identify intraday entry and exit levels usually after 2 or 3 session hours, with considerable trading activity, so look for heavy volumes. 

And finally, knowing the market context is key to applying all these concepts with success. Practice and study the different structures and histograms formed by the Volume Profile, to get the best benefit from this powerful weapon.

Good trading,
@BravoTrader

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