How to Read Volume Profile Structures

Authored by Ivan Delgado Egea, Head of Market Research at Global Prime Forex.

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As a trader, you are probably accustomed to using concepts such as horizontal lines of support/resistance, trend lines, Fibonacci retracements, round numbers, or other forms of studies to spot reactive areas in your chart, right?

What if you could add the study of volume through the Y-axis of your chart to pinpoint with striking accuracy areas where the price may see a reversal. What if you could also gain an unfair yet real advantage by anticipating the type of market context most suitable to trade with the trend based on the different volume profile structures by the end of the New York close?

In this article, I will unveil an extremely useful tool, widely used by banks and financial institutions, that goes by the name of “volume profile”. Firstly, credit where is due. The father of market profile — from where volume profile evolved from — , is a futures trader named Steidlmayer. Here is a link to his book “Trading with Market Profile”. Steidlmayer joined the Chicago Board of Trade in 1963, and has been an independent trader ever since.

What Is Volume Profile?

There are two ways of observing the total volume transactions in any market. As a spot forex trader, you can tap into tick volumes as an accurate visual representation of the total traded volume in the X-axis, which would then make your analysis be based on time.

Alternatively, you can carry out your volume study through the vertical Y-axis, in which case, you are analyzing the total activity based on price levels. It is this latter study what volume profile is about; it’s a histogram of the amounts bought and sold at specific price levels as opposed to specific times.

The volume profile allows any trader to evaluate the market context to keep track of the never-ending auction process. That’s what a market is at the end of the day, a constant negotiating process to find equilibrium/agreement (via the accumulation of transactions at a certain level), and the ones that were perceived too cheap or too expensive (no volume found). The art of reading volume profile is all about studying the anatomy of the market auctions.

Before taking things to the next level, allow me to walk you through some basics. When drawing your volume profile in the chart, you must become intimately familiar with the following values:

1. Point of Control (PoC): It refers to the area in the chart with the most traded volume activity. This is by far the most relevant area you want to monitor as it can help to define the placement of your stops or the areas in the chart where you might find the most pristine entry levels. The highest concentrated area of volume for a particular period of time we will call it PoC or Point of Control and you will be surprised how many times it acts as a wall on a retest. Traders tend to factor this in as an area of support or resistance.

2. High Volume Nodes (HVN): Sub-sequences in the chart with high volume activity. While not as powerful nor symbolic as the PoC, the HVN is also a powerful area as it also represents increased trading activity.

3. Value Area (VA): The range of price levels in which a specified percentage of all volume was traded. By default, the industry standards tends to be 70%. Once I explain the principle of the distribution curve below, it will become much clearer why the default number is the 70%, bear with me.

There are three different types of volume profiles to use in your charts. When you first call the volume profile option through the widely popular charting package trading view, the options include:

  • Fixed Range
  • Visible Range
  • Session Volume (Preferred)

I personally find the combination of the daily price action activity and its respective volume flows at specific price levels the most relevant approach as I will demonstrate in the next paragraphs. The session volume allows you to constantly obtain an update to re-evaluate the market, whereas the assessment of the fixed range or the visible range is more discretionary.

That said, the fixed and visible range options also serve as useful tools depending on the purpose of your analysis, that’s why I will also spend some time going through the most valuable benefits of its use.

Fixed Range: Selection Of Interest Levels A La Carte

Trading the markets, especially if you are an intraday trader, involves constant interaction with your charts. You are constantly looking for areas that you can lean against to take certain actions. Right? This first fixed range option allows you to select any area in the chart to deconstruct the total activity. This is a tool that can be of enormous value if you are looking to tighten or trail your stops as well as spotting areas of most interest to enter your positions.

Let’s say that you wanted to play a short in the EUR/USD 30m chart after the breakout of the range. A fairly conventional strategy would have been to wait for the price to break below the two horizontal support levels and enter short on a retest of either one of them. The next logical question would then be, where would you place your stop? If you are trading conservatively, you’d probably be placing your stop somewhere above the 1.16 in order to leave enough wiggle room in case the rebound returns back into the range.

However, if you think about it, there are other areas in the chart that still make a lot of sense to capitalize on. If you were interested in tightening your stop in such a magnitude that your short trade could exploit the prospects of a much larger risk reward, you could then be tapping into the power of the fixed range volume profile to identify at what price level after the range breakout the highest concentration of volume occurred. You could then use this as an area of relevance to assist your action as a seller. In the example, it may have been a great area to play with a much tighter stop.

There is a multitude of examples I could provide about the usefulness of the fixed range volume profile. However, since I want the core of this tutorial to be about the session volume structures, I’d refrain from further chart illustrations unless you want me to (post comments below). I am sure you can figure out how it could be of benefit to you, depending on your trading style.

Visible Range: The Macro View Of The Market

As the name indicates, the visible range option unpacks as much trading activity as data is in your chart. It portrays the big picture view of the most-traded price levels over a specified period of time.

This option is most suited as part of your daily or weekly analysis to spot areas of interest in the chart. By stepping back and projecting an eagle-view from a macro level, it helps you to easily identify key supports and resistances, which is what I mainly suggest to use the visible range for.

One of the most powerful approaches that I recommend is to select your macro areas of interest by zooming out your charts. Once done, you can start drawing horizontal rectangles at every high volume nodes (in black) or low volume node (in red). The areas highlighted will be by far the most relevant that you want to be paying attention going forward.

Session Volume: In Sync w/ The Day-To-Day Context

While the above volume profile options are by themselves very powerful, I refuse to accept that any can beat the ability to be reading the daily auctions.

The auction process in the last 24h of trading provides a roadmap from which to pre-plan your next trading day. If by the end of trading in NY, you are seeking out answers to the questions: What side is in control? Are buyers/sellers accepting higher/lower levels? What side is trapped and therefore has the higher chances of bailing out? All these questions and many more can find an answer via the session volume profile.

Types Of Volume Profile Structures

Single Distribution — Inconclusive Bias

If in the last 24h, the negotiating process ends up with no side in control of the price action, this is represented in the chart by a belly-type curve formation. At the extremes, you can clearly see the tapering of volume, which means an exhaustion of prices amid the lack of sufficient liquidity to find equilibrium. The dynamics of price discovery then suggest that price must revert back to the mean to find new two-way business/acceptance levels.

This structure leads to what’s often referred to as a market in a range. If you think beyond the conventional technical education, the formation of a range is nothing more than the test and failure to agree on higher or lower levels.

The market will constantly be exploring new prices up and down. However, what’s really important is not so much whether or not a level has been tested but the ability by market forces to accept it, thus building value. The thicker the volume on the Y-axis of the histogram, the more value is built as buyers and sellers come to agree on the new area of interest to transact business.

So, let’s tackle the key question. How can we get prepared to trade these structures the following day? Whenever we are presented with a single distribution aka a range, the areas of interest will include the extremes of the range or alternatively, the side in control of the POC (Point of Control).

As the chart below illustrates, the upside edge of the previous day’s single distribution never came even close to be re-rested, but what we did get was a clear rejection off the POC, which then led to a breakout of the range.

In the next example, we have the creation of another single distribution structure. The next day, the price recovers above the POC (red line) and starts to find acceptance with a subsequent backside rejection. That’s a major clue that the resolution of the range-bound conditions might come to a successful conclusion for the interest of the buyers. The moment that in a range the POC starts to act as support or resistance, that’s the first important hint that as a trader you want to pay close attention to gauge the next directional bias.

In the majority of cases, whenever we end up with a single distribution structure, the POC for that day will come nearby the 50 mid-point of the day’s range. This is not a coincidence, as one of the characteristics of the single distribution is its symmetrical structure in line with the principles of the bell or normal distribution curve.

One of the key lessons from the tutorial about the 4 Pillars in Forex included the relevance of the bell curve, which happens to be one of the backbones’s behind statistics and probability theory. It is also essential to understand for you as a trader if you are going to dig deeper into the study of volume profiles.

Remember that one of the natural laws of statistics is that as we increase the repetitious trials of random events that arise from flipping a coin, it results on a more pronounced skewness of results towards the center of the chart or bell shape. This is known as the central limit theorem. This is precisely what’s at play when we see the single distribution structure in volume profile. We have more and more order activity coming through the books with the pre-condition of not creating enough of an imbalance is supply or demand.

As the volume keeps increasing by N = number of times a new order comes in (times someone — human or algos— take a trade), the more pronounced the shape becomes, with the creation of another universal truth in statistics, that is, standard deviations. This states that over 68% of the volume will be accumulated under 1 standard deviation (in blue), while 95% of the volume will come within 2 standard deviations (in red). Now you will understand why the standard market value of a volume profile tends to be 70%.

Multiple Volume Distributions — Directional Flows

It refers to an auction process that creates two or more areas of value via a noticeable volume accumulation in the histogram. In the majority of cases, we will have the creation two distributions, less so a triple distribution structure. In the illustration below, you can find an example of a double distribution day.

As part of the double distribution structures, there are up to 4 subcategories we can classify. Each one of these structures suggests the likelihood of a distinctive price pattern to be expected the next day.

The critical factors that we must account for when evaluating multiple distribution structures include the number of thick areas in the histogram (value built) and the price close. There is a strong dependence on where the price closes by the end of the NY session to evaluate the next day’s play.

Let’s now break down these structures.

Short L-Shape (No Trapped Longs)

Following up with the example of the EUR/USD, in the following 24h, the pricing of the pair created a double distribution structure. As part of this formation, we now need to classify what type of structure it is based on where most of the volume was traded, as depicted by the POC (Point of Control).

On Oct 24, the price spent only a brief period of time before selling-off, leading to a price sequence of low-volume bars through the histogram. As the dust settled, buyers and sellers started to agree on the next level of equilibrium near the lows of the day around the 1.14 area.

This market dynamics are one of the most powerful for an ultimate trend continuation. If we were to decipher the clues behind the auction process, via volume profile, it clearly indicates that the market agrees on the value lower.

The fact that the majority of the volume was accumulated near the lows, and most importantly, with the price closing around the lows of the day near the POC, is a strong statement that the market is not interested in profit-taking.

Therefore, any potential rebound would most likely see sellers committed to adding to their short positions. This is a pattern that runs the risk of resulting in shallow rebounds before the continuation of the trend.

I will also illustrate below what a triple distribution looks like. Here it goes.

If the structure supports a short trade the next day, as in the case of the short L-shape, yet the close at the NY close is considerably above the POC, the prospect of shorts trapped or at least choppier moves the next day increases.

As a rule of thumb, if the price closes above the 50% Fibonacci retracement of the day’s range on a short L-shape, be wary the trend continuation would be more debatable the next day, with risks of a range or a reversal growing.

Another version of the short L-shape is when the daily range is compressed. If that’s the case, even if at first glance it looks like the pair may have entered a range, the actual structure of the volume profile and the close near the lows of the day, suggests the potential for short opportunities the next day.

Short P-Shape (Trapped Longs)

The next day (Oct 25th), the bearish trend in EUR/USD follow its course, but interestingly, the volume profile structure carried a different message. The majority of the value was built to the upside, while the downside saw comparatively lesser activity as depicted by the volume profile (chart below).

All the buyers at the top that facilitated the build-up of value are now trapped, which means that any rebound towards the POC becomes an interesting proposition to add shorts, especially if in line with the underlying trend. Remember, I have written a detailed tutorial on how I determine market structures in case you’d like to check it out.

Unlike the short L-shape, this Short P-shape tends to see a larger rebound as market participants fail to find sufficient two-way business at the bottom. It eventually leads to exhaustion before a potential recovery of the price (the rebound expected) as part of the market’s price discovery mechanism.

When this pattern occurs, any continuation lower without a prior rebound runs the risk of exhausting and trapping late weak-handed sellers, unless there is a significant build-up of value into these newly found lower prices.

Below, I illustrate one of the potential nuances that you may come across. Even if at first sight the structure may suggest a single distribution, the fact that on the upper 50% of the daily range buyers failed so miserably to build any value at all, combined with the price closing at the lows, it screams danger ahead. On closer inspection, this is a pattern that would be more fitting for the short P-shape (trapped longs) category.

That’s the reason why I wanted to add this chart as part of this category. If the close had been towards the middle of the daily range, the outlook the next day may be murkier, but since the short P-shape supports the bearish close, in aggregate it adds to the risk of a downward continuation the next day.

Long L-Shape (Shorts Trapped)

Unlike the previous subcategory, we now find ourselves with a bullish structure forming an L-shape (Oct 19). When this happens, our hypothesis must always be that unless new pockets of liquidity by long-side players are created at these highs, there is an inherited risk by this type of structures for the move to run out of juice (exhaustion), resulting in a deep pullback.

It is in these type of retracements that we may see the best opportunities to engage in buy-side business as the pricing of the pair returns to retest an area where sellers got trapped the previous day.

However, by the end of the next day (Oct 22), notice how the price creates a short L-shape? If you were playing longs off the Oct 19th POC, this type of counter-formation should be a major red flag as the auction process is now communicating a market that is accepting a new valuation lower.

Long P-Shape (No Trapped Shorts)

In this situation, there is a risk of a follow through continuation with the trend right off the bat. By checking the chart example below (Sept 20), this is precisely the case before buyers are overwhelmed by the supply imbalance.

Despite the setback, the context would still be favorable to look for buy-dip opportunities as the latest indications are that both buyers and sellers agreed on higher price levels near 1.18 as the newly found equilibrium.

When these structures occur, the buyers that kept the price bid up this high are not going to give up without a fight, and that’s where the opportunities to buy the dips tend to arise. The next day (Sept 21st), the volume structure results in a short P-shape with longs trapped. Do you remember what I mentioned about this pattern? It tends to create an initial fake-out move that exhausts itself prior to the price being attracted like a magnet back up towards the previous POC (Point of Control), where the next battle is due.

The fade out of price on Sept 21st was also supported by the previous day pattern, which happened to suggest that buyers would still be interested to bid up the price as per the value build around 1.18 the previous day. By keeping track of the most recent volume profile structures, you can undoubtedly add more conviction to your trades the next day.

Putting It All Together

We’ve come to the end of this guide. As I always recommend, take your time to practice the varies concepts and structures shared in this tutorial. Ask yourself if any of these lessons can be of any benefit to your trading approach. Be reminded that you should factor in these new concepts as part of a holistic approach to the markets. If you fail to understand your surroundings by not conducting the proper multi-timeframe studies, you might be missing part of the picture. What if we get a text-book long P-shape structure but it happens to be trading straight into an area of daily or weekly resistance? What if we have a tier 1 event coming up which we know is going to distort the structure? Again, knowing the context is king to apply these concepts with success. If you do it diligently, you will be hard-pressed to put in doubt the usefulness of the volume profile as a tool to decipher the market intentions via price auctions.

Bonus — Chart & Video Demonstration

Video coming up…

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