Volume Profile is one of two tools that are a must in our trading strategy at TRADEPRO Academy. The volume profile is a tool that allows traders to see the volume on a horizontal level at each price. Meaning at some price levels there is a lot of volume and at some very little to none.
The importance of this tool lies in the fact that volume attracts price. Meaning large areas of volume become favorable price magnets. Throughout this comprehensive guide to volume profile, we’re going to break down the volume profile and how it can be used to trade the futures market.
Volume profile allows futures traders to see where the price is most likely to trade and the direction of price movement to a higher degree of probability.
All of the charts and examples are going to be based on the S&P500 E-mini futures throughout this comprehensive guide. However, you can apply these principles to any futures asset.
Understanding Volume Profile
Volume profile is a technical tool that allows us to see how much volume trades at each level. When it comes to the volume profile and futures trading, things can get a little complex.
Futures Contracts expire each quarter, meaning the volume accumulates for the front-month futures contract and then disappears. Leaving the new front-month futures contract with very little volume and in turn very little volume profile. That means it is recommended to use a continuous contract when looking at futures volume profiles.
A continuous futures contract accumulates all the volume from all the past expired months of trading, allowing us to see a concrete volume profile with a thicker volume.
There are many aspects of the volume profile that traders should understand:
1. Time Period: The volume profile is calculated over a specific time period, such as a day, week, month, or any other desired timeframe. The chosen period determines the duration for which the volume of data is collected and analyzed.
2. Price Range: The price range refers to the range of prices included in the volume profile analysis. It typically covers the high and low prices of the selected time period. Traders can choose to focus on a specific range or use the entire price range.
3. Volume at Price: The volume at price component represents the volume traded at each individual price level within the selected price range. It is displayed as a histogram, with each bar representing the volume traded at a specific price level.
4. Profile Shapes: The volume profile can exhibit various shapes depending on market conditions and the behavior of market participants. Common profile shapes include a bell-shaped distribution, double distribution, skewed distribution, and others. These shapes can provide additional information about market dynamics and potential trading opportunities.
5. Composite Profile: A composite profile is created by aggregating multiple volume profiles from different time periods. Traders often use composite profiles to analyze the volume distribution over extended periods, which can reveal long-term support and resistance levels and help identify significant price zones. There can be variations of these seen on TradingView. Just like the visible range profile, the cumulative profile, the stagnant profile, etc.
The Volume Profile also has more internal components:
6. Value Area: The value area is a key concept in the volume profile and represents the price range where a significant portion of the trading volume occurred. It is often defined as the price range where 70% to 80% of the total volume is concentrated. The value area can be used to identify areas of high liquidity and potential support or resistance levels.
7. Point of Control (POC): The point of control is the price level at which the highest volume was traded within the selected time period. It is the peak of the volume profile histogram and is often considered a point of interest for traders. The POC can act as a magnet for price action and can provide insights into market sentiment.
8. Value area high & low (VAH, VAL): These are the two points at the tops and bottoms of the value area that indicate that the value area has ended. These typically act as “basic” points of support or resistance. We’ll break down what “basic” means in the coming sections.
9. High Volume Nodes & Low Volume Nodes (HVN & LVN): Important two aspects that would create large areas of volume and small areas of volume. Price is attracted to high-volume nodes and passes through low-volume nodes easily.
10. Distributions: Day traders should marvel at this aspect of the volume profile. A distribution is commonly referred to as multiple high-volume nodes grouped together. This creates a volume profile belly, which is the key aspect in the day trading distribution theory. (more in the next section).
11. Ledge: A ledge in the volume profile can be seen as high volume drops off into an area of low volume. Traders call them; shelves or have multiple other names. These are the more “advanced” areas of support and resistance as they restrict price movement from distribution to distribution.
Here is a visual representation of numbers 6 through 11 on the volume profile.
Interpreting Volume Profile
Volume profiles allow traders to see multiple different things in the markets:
- Distribution theory & patterns
- Key levels of support and resistance
- Trend analysis
1. Distribution theory & patterns
Distribution theory is the main concept of the volume profile. The fact that the market movement relies on distributions to move. Distributions can be understood as areas of compression, a market range, or balance. These are all synonyms for distributions.
If we understand distribution theory in terms of compressions (balances) and expansions (imbalances) we can get a better understanding of how the markets move.
Markets move in compressions 70-80% of the time which is a range. This is an area where there is no new information entering the market and we have strong-handed buyers and sellers trading at the tops and bottoms of those ranges. These compressions are exactly what create the balance and the distribution that you see in the volume profile.
These distributions are known as the attractants for the price, as long as the price stays within this distribution we’re going to see price trade at the tops and bottoms of distributions holding the compression.
When the price escapes the distribution you expect to get an expansion, the general rule of thumb is into the next distribution.
If the price should escape out of the top, then it will look for upside distributions. The same thing if it escapes from the lows, downside distributions are going to be looked for.
Understanding this is one of the greatest trading tools you can have in your arsenal as a short-term or long-term trader.
A general rule of thumb, if the price opens outside of distribution, whether it’s upside or downside, that leg in that direction is expected.
An imbalance area or an area of expansion is known for its very low volume, this is where the price would escape out of a distribution ledge and run through low volume easily.
These are the areas, like in the image above traders would want to trade the most in, this is where the majority of the money can be made as a trader. Whether your buying or selling into these imbalances.
Some patterns that you want to take note of in distribution theory are whether the price is within a distribution balance or outside. These can dictate the potential of the move.
2. Key levels of support and resistance
Key levels of support and resistance using volume profiles and trading futures are a form of technical analysis that traders need to practice. This is not as straightforward as seeing a price action high and marking it as a resistance.
This is also why I mentioned that value area highs and lows are general guidelines to “basic” support and resistance areas. This is because they do not always encompass a normal distribution. A normal distribution is an even belly.
This is why we look at the overall cumulative distribution on a volume profile that spans 30 or 50 days of price action volume.
Simply put, key support and resistance levels can be found as distribution ledges. These ledges have high importance because they are where strong-handed traders get activated. Whether the price is inside or outside of distribution.
A ledge is an area where high volumes nodes drop off into low-volume nodes. Creating a shelf in the volume profile.
If the price is within a distribution the ledges at either extreme are key support and resistance level to keep prices within the distribution. If the price is outside of the distribution, the same holds true in that prices staying imbalance would hold the distribution ledges to keep imbalance (outside of distributions).
Take the image below as an example, the main distributions are in the rectangles and the key ledges surrounding the white lines.
3. Trend Analysis:
Using a volume profile for trend analysis is very important as it can give you a clear understanding of what the expected move is. That doesn’t mean looking through the crystal ball, but instead getting a strong understanding of what expected moves in price look like based on volume profile analysis.
It’s fairly simple. Start with the notion:
1. Is the price within the balance & going to open within the balance
2. Is the price outside of the balance & going to open outside of the balance
1 a. If the price holds within balance and the price is about to open within balance, traders can look to trade the compression if it is wide enough. Expected range day where the balance extremes can hold support and resistance.
1 b. If the price holds within balance but is going to open outside of balance. Traders can expect a trend day in the direction of the opening outside of balance.
2 a. If the price is outside of balance and still holding outside of balance on open, then traders can expect pullbacks to continue the trend overall.
2 b. If the price is outside of balance and is going to open within balance, then traders can expect the possible range day but also if key supports/resistances hold there is a chance that the price becomes imbalanced again.
Session Volume Profiles vs Cumulative Volume Profiles.
These are two different profiles that represent different time frames of volume. The cumulative session profile combines multiple days of volume which allow us to see the volume as it has formed.
The session volume profile allows traders only to see each volume profile based on sessions.
They both have their merit. However, when understanding the grand scheme of the market story and the overall market movement it is preferable to start at the large volume profile (cumulative) where you can break down overall distributions. Then look at the individual session profile.
The cumulative profile allows us to see the large distributions that might span 20 and more points on the S&P500 E-mini futures. This allows traders to differentiate between balances and imbalances. In the following section, we’re going to break this down further and what this means, when we talk about volume profile strategies for futures trading.
In the meantime, the chart below is a visual representation of the cumulative 50-day volume profile (yellow) and the individual session volume profile (blue) on the ES E-mini, using Sierra Chart.
Practical Applications of Volume Profile
Using the volume profile to identify market auction theory and distributions is the best use of this tool. We are looking for distributions to find what the expected market movement is.
The main breakdown of how to do this:
1. Use the large (50-day) profile to find not only large distributions but also key support/resistance ledges.
2. Use the individual session profiles to find where there are large traders outside of the value area.
Understand where you have large distributions based on the cumulative volume profile, this can be a 50-day. You want to identify if the price is currently in a balance or if it’s outside of balance.
When you identify large balances, the price has the expectation to stay in that large balance area. Otherwise outside of the balance price is expected to run into the next large balance area.
If you take the image above, you can see there are a few large balances within the yellow box that stick out. The main happens to be in the middle of the yellow box. This is to be used as a magnet and an area of expected price rotation.
Identify what the traders have done in past individual sessions. Meaning where was volume found in prior sessions that happens to be outside of the value area. If there are a lot of traders (volume) at the top of the value area.
Then you have the expectation that the price can roll over to the downside. Likewise, if there is a lot of volume building at lows, then the expectation is for the price to push higher.
Combine Steps 1 & 2 together. Let’s break down an example.
In the image above, we’ve broken down 3 main distribution blocks (yellow) & the example session used is the overnight session where we have the blue box that indicates overnight.
These are real-world examples of volume profile analysis, based on the S&P500 E-mini futures. In this circumstance we can see that price is OUTSIDE of the yellow blocks, meaning price is imbalanced.
We also want to take note of where price came from (the downside & broke through distributions to the upside). This puts upside pressure on the market.
Then notice the overnight session, in the blue box we have a lot of volume at the highs building, which would suggest a reversal back into the top of the prior balance to take a run higher again. So we would expect resistance at 4458-60, a pullback into 4442-44 then upside again in the ES E-mini futures.
Let’s see how the day played out on a candle stick chart:
As expected, our regions and analysis played out.
Tools and Software for Volume Profile Analysis
There are several tools and software that traders can use when looking at Volume Profile Analysis.
Here are our favorite volume profile indicators and tools:
- Trading View
- The visible range profile (built-in)
- The session profile (built-in)
- Sierra Chart
- Cumulative Volume Profile
- TPO/Volume Profile chart
Tips and Best Practices
Best practices for volume profile analysis should involve understanding distribution theory and how markets move based on market participants. Distribution or Auction theory is laid out here in this blog, but you can also watch the following youtube video to get a better idea.
Distribution or Auction theory allows traders to find where markets are balanced or imbalanced in expectation of a move.
You can discern price compressions from expected expansions to even identify where the price is headed.
Volume profiles have immense power when trading futures, and even other assets.
Overall we can look at volume profiles as tools to understand distribution theory, which stems from how market participants enter the market and how they are able to move price.
Breaking down where large market participants might be active is a huge advantage. This allows traders to understand where large market participants might be entering trades and where they can place their stops.
In this comprehensive guide, we’ve shared a lot about the volume profile and how to use the information to your advantage as well as where to use the volume profile.
We hope you enjoyed reading and learned a lot. For more information on the volume profile, you can check us out our futures course at TRADEPRO Academy.com