Have you ever watched tutorial videos on YouTube of trading pros explaining how they follow market movements? Did you happen to notice that most of these traders weren’t looking at composite candlestick charts? That is because day traders are not overly concerned with large data sets, which tend to over-complicate our cognitive rationale. No, in fact, they are only concerned with what is happening right now. That’s why following order-flow and paying attention to volumetric symmetry, or volume profile, is very important.
I have been trading for over a decade, both as a money manager, and proprietary trader. When I left my last money management position, I was eager to bring the tools of my trade to the Bitcoin space. There was a glaring lack of sophistication surrounding the technical analysis Bitcoin traders used to make decisions. Almost 100% of the early TA was based on composite charts and offered very little in the way of real-time price action and order-flow analysis.
The real question becomes, what’s the edge? How can you gain an advantage over every entry-level trader trying to profit from this upcoming Bitcoin bull-run? The easiest way is to get familiar with making decisions based on market symmetry. What does that mean, you may be wondering? Simply put, all markets are the same: they are merely auctions. It’s no different than people bidding on a rare painting at Sotheby’s, or a Honus Wagner original rookie card. There is supply (the ask) and demand (the bid), when an agreed-upon price is found, a trade occurs (the market). At the end of this auction, a distribution curve is formed and leaves clues as to what traders were thinking during the auction process. The volumetric signatures left behind from the auctions can be extrapolated even further and used to theorize about where price will go next.
Knowing the psychology of other market participants is crucial while day trading or scalping large size. When a trader speaks of Market profile or volume profile (the distribution curve), they are alluding to how we traders read the overall symmetry of the price action in a particular ticker symbol. An even (or balanced) market, tends to form a perfect distribution curve, such as the one featured below;
What does that mean, you might be asking? Well, when the curve looks like it does above, that means the market has achieved balance or symmetry. Markets trend until they achieve balance. Liquidity (price action / order-flow) starts and stops all moves in any market. The liquidity is ultimately searching for the aforementioned balance. During the process of achieving balance, there are other types of volume profiles (distribution curves) that give us clues as to what traders are thinking, and where price might be headed next. In the distribution curve listed below, you can clearly see the shape of a P, which indicates that the price has not achieved balance, and market participants are likely to drive prices higher.
This is because most trading is happening at the upper end of the price range, so the profile appears fat up top and skinny below, forming the ‘P’ shape. If price was to achieve balance (evenly distribute), it would likely continue rising, in order to ensure that the POC (point of control, or where the majority of trading occurs) rotates to the center of the range and not the top (uneven distribution). All of the business being done in the center of the curve would create an even distribution, and form a curve as shown in the first illustration (or a ‘D’ shape).
There are some exceptions to these patterns that I will cover in future posts.
Finally, our third and final profile type is the ‘B’ shape, which indicates that price is targeted at the bid and being driven lower as a result. As you might have just guessed, this is the exact opposite of a P shaped profile. Most of the trading activity is being done at the lower end of the range, and thus creates a skinny profile up top and larger distribution below. This again gives us the indication that the price has not found balance, and is likely to be targeted by sellers until balance is ultimately achieved.
The point of control (POC) plays a very important role in all of this as well. It is the gauge of where the ‘herd mentality’ is for the moment. The point of control, simply put, is the area where most of the trading on the distribution curve is being done. It’s the most commonly accepted price, so we refer to it as the Point Of Control (POC). You always want to know where it is on any profile set up.
It is also helpful to use the tails of the distribution curve (Low Volume Nodes, or LVN) to enter into your trades while exiting into the POC. Low volume areas of the profile (LVN) tend to act as support and resistance. If the POC rotates to the center of a P or B shaped profile, it’s a pretty safe indication that it will continue in that direction until something comes and changes it.
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Using these three simple profile setups will help you enter into better trades, ride them longer with more confidence, and help your risk management capabilities as a result. Of course, this isn’t all there is to trading with volume profile and order-flow analysis. Sign up for a free account, and in our next blog, I will explain the special signatures left behind during moments of profile elasticity and price discovery. You can only find these tools available to you via Cignals, so don’t miss the best market moves during this bull-run!
