Volume Profile is an advanced charting study that displays trading activity over a specified time period at specified price levels.

The study (accounting for user defined parameters such as number of rows and time period) plots a histogram on the chart meant to reveal dominant and/or significant price levels based on volume. Essentially,

Volume Profile takes the total volume traded at a specific price level during the specified time period and divides the total volume into either buy volume or sell volume and then makes that information easily visible to the trader.

The first thing that most traders will use volume profile for is identifying basic support and resistance levels. It is important to note that using Volume Profile as an identifier for support and resistance levels is a reactive method. This means that unlike proactive methods (such as trend lines and moving averages) which are based on current price action and analysis to predict future price movements, reactive methods rely on past price movements and volume behavior. Reactive methods can be useful in applying meaning or significance to price levels where the market has already visited. Basic technical analysis has shown that a support level is a price level which will support a price on its way down and a resistance level is a price level which will resist price on its way up. Therefore, one can conclude that a price level near the bottom of the profile which heavily favors the buy side in terms of volume is a good indication of a support level. The opposite is also true. A price level near the top of the profile which heavily favors sell side volume is a good indication of a resistance level.

Example strategy

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Just like with most other tools or studies, Volume Profile has a number of uses. There are many trading strategies out there using Volume Profile as a key component. Below are the basics of one such strategy which is based on comparing the current day’s opening price to the previous day’s Volume Profile.

• If the current day opens above the previous day’s value area (but still below the Profile High) look for price to retrace back towards the Point of Control and then proceed to rise (the direction of the day’s open). Therefore during the retracement to the Point of Control, there is a buying opportunity.
• If the current day opens below the previous day’s value area (but still above the Profile Low) look for price to retrace back towards the Point of Control and then proceed to fall (the direction of the day’s open). Therefore during the retracement to the Point of Control, there is a selling opportunity.
• If the current day’s opening price is completely outside of the previous day’s profile (above the Profile High or below the Profile Low) this can be seen as a possible runner in the direction of the opening price relative to the previous day’s profile range.

Volume Profile is an extremely valuable technical analysis tool that is used by traders everywhere. The key to Volume Profile’s continued relevancy is its versatility. It is a charting tool that truly does have a wide array of uses. Unlike many other studies, there is little to no debate about Volume Profile’s usefulness. The data that is provided by Volume Profile is indisputable, leaving it to the trader to find new and creative ways to use it. Even though in its simplest form, it is a great reactive method for discovering traditional support and resistance areas, traders are still coming up with ways to chart the indicator in predicative or proactive ways. Consider the trading strategy example given earlier in the article. Being able to compare a real-time event (the current day’s open) with historical events (the previous day’s volume profile) and make a trading decision based on the relationship is a great example of this.

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