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Simplifying Volume Profile Part 2

Value, and How to Incorporate it into Technical Trading.

We left off Part I with the simple statement: 

“Most all the time you should be a buyer below value and a seller above value.”

We’ll now look at our first picture of a volume profile to see what “value” means in this context.

I am intentionally not using the example from Part I as that will serve as an exercise for you to do on your own before Part III. 

Here is a picture of the volume profile as it existed for the overnight ES_F session From Sunday March 11, 2024 and I’ve intentionally ended the profile as of 4:05AM because we will next look at a trade setup that took place after price made a new low of session. “Value” had been established for 10 hours for the session.

The blue bars represent the volume that was traded at each price. Thus, a volume profile is volume at price, whereas most traders look at volume by time.

Different profiles will have different shapes and those shapes can be interpreted differently. That is beyond the scope of this section and isn’t necessary for this application we will discuss. The more prominent blue area represents the “value area” for the profile with the orange line (the Volume Point of Control or VPOC) representing the price traded with the most volume for the range. You can see in this profile shape it is quite nicely a bell-shaped curve. This is called a D shaped profile, but again isn’t necessary to remember for this application. 

What IS important for this application is the “value area” and the VPOC which represents the “fairest price” for the session. In order for a transaction to take place there must be a willing seller and a willing buyer at that price. Thus, the largest number of participants on both sides saw this price (VPOC) as fair and reasonable. The “value area” on this profile represents the area of the bar graph that captures 70% of the volume traded. This is the more prominent blue whereas the bars that are less prominently colored (darker shade) are considered outside of the value area. 

Note-Some traders will use different settings for value area. That also doesn’t matter for this application.

For the below picture I have adjusted setting so that the top of the value area (the Value Area High or VAH) has an extended blue line at it, and the same for the bottom of the value area (Value Area Low or VAL). I do this for visual purposes. Again for visual purposes I’ve labeled the VAL, VPOC, and VAH with purple horizontal levels. The yellow horizontal was simply the low of the session (12:05AM EST) before price proceeded to make a new low starting with the 4:05 AM candle. The green levels represent technical support for the day which your average technical trader would have had (particularly 68).

Let us revisit our one sentence:

“Most all the time you should be a buyer below value and a seller above value.”

As of this session, which had traded for 10 hours overnight (it trades 15.5) value had been established between 5181.75 and 5191 with some excursions on both sides that quickly snapped back into value.

Am I going to initiate a short position on this breakdown to a new low of the session below 5179.5? 

“Most all the time you should be a buyer below value and a seller above value.”

Am I going to be hesitant to get long off technical support because “price is going down its bearish?”

“Most all the time you should be a buyer below value and a seller above value.”

Not only am I confidently longing this area 19 times out of 20, I know exactly what my target is because of the volume profile. If price trades outside of value and that move is rejected, then price will return to what has been established as “value.” My first target is the VAL, and then the VPOC. If there is continuation then perhaps VAH. But the “fairest price” is VPOC.

You can see how the 4:20 candle stalls briefly at the VAL, then resumes to precisely VPOC before rejecting back down. Zoomed in:

So here’s a real-world example of what just happened:

You’re selling your lambo back to the car dealership because you keep shorting below value and you’re now poor. The dealer knows that he can resell the lambo for between 5181.75 and 5191 with most of them going for 5187.5 (lambos are going for really cheap from all the perma-bears shorting this market). He takes advantage of your plight and willingness to sell it to him for 5172.5. In this case he didn’t really want the lambo at all, but he knew he could flip it from 5172.5 to 5187.5 in 20 minutes.

You’ll notice that 15 minutes after the dealer unloads his used lambo at 5187.5 for a nice profit, he takes advantage of another suffering permabear willing to sell to him at an even better price of 5170.25. He unloads it 20-30 minutes later at 5187.5 for an even better gain.

Key takeaways:

-Avoid shorting below value (or buying above value) most of the time (exceptions are more advanced and truly are the exception).

-Know your primary target for your trade, at least for your core position.

-Have more confidence to initiate the trade that you otherwise might have been nervous to take.

EXERCISE:

Now go back on your own to the 2/21/2024 example. In TradingView (or other platform) use the indicator “fixed range volume profile.” The start time should be 09:30 EST. For the ending time, drag the profile to include everything up to just before each of these hypothetical trades. Evaluate for yourself what may have been suboptimal about these trades given the developing profile information at the time.