Introduction to Volume Profile
Most know volume as a tool tracking Volume by Time, but Volume Profile shows Volume by Price. Rather looking at when buyers/ sellers stepped into the market we can now see at what price these buyers/ sellers stepped in. Allowing to see at what prices institutions are participating marking what is and is not a fair price, and value. This is used to form context around prices giving possible indication where the market wants to move. None of this can be seen with volume by time or any indicator that many traders will throw at you, all of that is nonsense. Volume Profile alone can guide you through markets if you use it properly. Everyone will find what works best for them but in the end Volume Profile is superior to everything. If you want to dig even deeper into Orderflow stay tuned for my DOM (Depth of Market) series that will be coming in the future. DOM shows each order going through but also what type of order, adding context to the trades. Early 2023 I will roll out a substack on risk management so you can then apply volume profile setups with a profitable trade system. This will show you exactly how I map out all of my stop losses. Let's dive into the Volume Profile...
What is a bell curve and how can we interpret it?
Many have seen Bell Curves before which are how we interpret Volume Profiles. This breaks down Profiles into areas of value which are known as Value Area Low, Value Area High, and Point of Control. Using these values is one of the ways you can form a system to trade around. Using the same concept of Bell Curve distribution, we apply these same values to Profiles which can vary depending on the timeframe being used. In Bell Curve terms these are known as the standard deviations.
A standard bell curve is broken into 3 standard deviations which is symmetrical on each side. When looking at profiles this will be very hard to see on your own, but platforms have tools that can map these areas out automatically. Noting the standard symmetrical Bell Curve, the areas go as so, 34.1%, 13.6%, 2.1%. Knowing these areas, we can know that between 34.1% area, sits in 68% of the value area, and 13.5% and beyond is 99% of the value area. Each area has its own meaning and can tell signs of what may happen next offering plenty of opportunities.
This will not be familiar at all but with time and practice you will become natural with all of this. It will take months to years of screen time but over time you will realize how prices react to these value areas. Taking notes each day will help significantly as you will notice how stocks behave relative to how value is distributed. Set a solid understanding of Bell Curves before moving on to learning about Profiles, or else this will confuse you.
Standard Deviations, VAL, VAH, POC, Mean Reversion
Don't expect to be able to look at profiles and instantly see bell curve distributions. Note when in a bull market making ATH, we are creating new pockets of value which you will then have to watch new areas of value form. Without seeing a complete or nearly filled-in curve you will be confused about what will come next. Once through this, you should have a relative understanding of how to approach all market conditions.
The reason this was brought up was key terms you must know will be VAL, VAH, POC, HVN, and LVN. Depending on how much of the bell curve is filled in will determine where these values line up. Profiles nearly filled in will have the most potent levels. The point of the Profile (bell curve) with the most volume is known as the POC. Prices will treat this level as a magnet which will be used more times than not as a target. VAH and VAL are symmetrical as in they both are 34.1% of the volume from POC. This is the first standard deviation from the POC (point of the bell curve). Putting a bell curve sideways you place the VAL at the 1st lower standard deviation and VAH at the 1st upper standard deviation. We now can say that 68% of the volume was traded between VAL & VAH. Market over 70% of the time is balancing between prices which VAL & VAH are great references to these areas of rejection. Values outside of the 68% of value I don’t pay attention to unless we begin to shift value outside of the bell curve. For quick thoughts on these terms, possibly Short VAH and Long VAL with both targets set to POC or the other side of value. So Long VAL to POC / VAH or Short VAH to POC/ VAL. Another idea is when the price ventures to a new value you can take the same approach but keep the target being POC.
POC = Highest point of Profile (Most Volume)
VAH = 1st Standard Deviation above POC (upper 68% of Volume)
VAL = 1st Standard Deviation below POC (lower 68% of Volume)
IB = Initial Balance (1st hour of Cash Session RTH)
How bell curves look as profiles
Unfortunately, this is not an exact science, and the Profiles will not look exactly like the Bell Curve and sometimes look nothing like one when seeking new value (trend day). Knowing this means there are different types of profile structures that can pan out. The goal is to spot the day type early in the session to set the tone for the rest of the day whether that’s short bias or whatever market conditions are prevalent that day. Each day is completely different so let's begin with laying out the basics of what balanced and imbalanced markets mean.
Balanced Market: These are range-bound days and are the most common out of all of them. My personal favorite to trade as there’s nearly a setup Daily. Balanced markets show there is a lack of conviction among the other timeframe buyers and sellers which typically results in a two-way auction process and the price movements occur within the range.
**All Examples below will be based on the BLUE Profiles (Daily)**
Imbalanced Market: Trending Market (uptrend or downtrend). This shows the conviction of other timeframe participants. Price will move in once direction with bumps of volume throughout the profile. The example below was an FOMC meeting which drove prices higher late in the day. Creating bumps in the Profile on the way up with no balance taking place.
Non-Trend Day is a balanced volume profile that occurs before an event, or news, another one is post earnings which can result in a lack of participation in the market. Range (high-low) for the day is very compressed and the risk-rewarding nature for an intraday trader is very less. Such days are characterized by low volume where long-timeframe player's dominance is clearly missing and the day is purely controlled by day-time traders. Only scalping the market favors an intraday trader on these non-trend days.
A normal day is a balanced volume profile but with a wider Initial Balance. It occurs in 65% of the total profile. The structure will be wider than all other days. Trading centers around the point of control (fair place to conduct any business). One-sided range extension is seen or at time price trades around the wider initial balance with more trading activity balancing around the point of control.
Normal Variation Day is usually an imbalanced profile, with majority of participants being long term (Buyers or Sellers). Long term participants are waiting for the market to settle down where they consider the price to be fair and then they drive market aggressively post 1100 EST or 1200 EST with the range extension outside the initial range. The range extension is more than 2 times the Initial Range and the Initial Balance is typically smaller than the normal day but higher than the trend day.
Trend day is an imbalanced profile that’s controlled by the long term participants. As soon as market opens, they begin to push prices into direction an continue for the remainder of the day. These trends are cause by long term participants stepping in. Other market participants have no options other than aligning in the direction of a longer timeframe. This tends to open up a range far exceeding the averages in recent days which in turn results in short term participants getting blown out.
Double Distribution is an imbalanced profile that has two nodes as price rotates away from short term participants in the IB to new value by long term participants. Then, the larger timeframe traders take control and drive the price in one direction. In the later session, another price rotation happens at the other side of the edge (2nd Balance Region). Both the price rotation regions should be separated by single prints. Risk-Reward Ratio is typically higher for a day trader during Double Distribution Days.
Neutral Day Center has a balanced profile with a smaller range than a Normal day. This happens because both long term buyers and long term sellers are prevalent. They don’t trade directly each other but the intraday trader will act as a mediator between both the larger time-frame buyer and seller. Range Extension happens on both the sides (i.e., Initial Balance Breaks out on both the sides). First half will slow and choppy with low volume but the second half will be taken over with larger size orders and price finally manages to close around the center of the profile.
