Volume Profile is a trading indicator that shows the amount of volume traded at each price level over a specified period. Unlike traditional volume indicators that only show volume per time period, the Volume Profile provides insight into the actual price levels that are significant due to high trading activity.
Imagine a sideways histogram overlaid on your price chart. Instead of showing volume over time (like a regular volume bar), VP displays volume at specific price levels. The fatter the histogram at a particular price, the more trading activity occurred there. This helps you visualize where the “smart money” is playing.
This helps traders understand where the majority of trading has taken place, indicating strong support or resistance levels.
Key Takeaways
- Volume Profile helps traders understand market sentiment.
- It reveals price levels with significant trading activity.
- Useful for identifying support and resistance zones.
Why Volume is necessary to know in trading?
Volume is a very important factor when people are involved in making anything important.
A film’s success, like a hit TV series or popular online content, hinges on its audience size. Volume, whether it’s moviegoers or viewers, drives success.
Trading follows the same principle. Volume, the number of shares traded, dictates stock price movement. Without volume, there’s no action.
This article delves into:
- Volume Profile: What it is and how it’s used
- Volume Calculation: Understanding the numbers
- Volume & Price: The interconnected relationship
- Candlesticks, Support/Resistance & Volume: How they work together
What is a volume profile?
Simply put, volume is the number of shares traded in a given company in a given period. When a price movement occurs with high volume, it is considered more reliable. And we can expect this movement to continue. However, if the movement occurs at a low volume, the authenticity of the movement is always questionable.
To confirm a pattern or apply a technical indicator to the market, the volume profile plays the most important role. It plays an important role in confirming market trends or patterns.
It also plays a very important role in understanding the prospects of the buyer or seller. Even the strongest technical indicator or pattern can be of little value without significant volume.
Quick tip: Market profile or MKTP is a synonym for volume profile. They are used interchangeably.
How is volume calculated?
The volume profile is essentially a horizontal histogram that displays the volume traded at each price level during a specific time frame. To calculate the volume profile, the following steps are typically followed:
- Define the Time Period: First, you need to select the time period for which you want to analyze the volume profile. This could be a trading session, a day, a week, or any other time frame relevant to your trading strategy.
- Divide the Price Range into Intervals: The entire price range during the selected time period is divided into smaller price intervals or levels. These intervals can be fixed (e.g., every 0.5 points or 1 point) or based on a dynamic calculation (e.g., using Average True Range or Volatility).
- Calculate Volume at Each Price Level: For each price interval, the total volume traded within that interval is calculated by summing up the volume of all trades that occurred at those price levels.
- Plot the Volume Profile: The calculated volume for each price level is then plotted as a horizontal bar on the chart, creating a visual representation of the volume distribution across different price levels.
Let’s illustrate this with an example from the Indian stock market:Suppose we want to analyze the volume profile of Reliance Industries Limited (RIL) for a particular trading day. We’ll divide the day’s price range into intervals of 1 point (₹1) and calculate the volume traded at each price level.
| Price Level (₹) | Volume Traded |
|---|---|
| 2,300 | 1,000,000 |
| 2,301 | 500,000 |
| 2,302 | 2,500,000 |
| 2,303 | 1,200,000 |
| 2,304 | 3,000,000 |
| 2,305 | 1,800,000 |
| 2,306 | 900,000 |
| 2,307 | 600,000 |
In this example, the price level of ₹2,304 had the highest volume traded (3,000,000 shares), indicating a significant level of interest from market participants. This price level would be considered the Point of Control (POC) for that trading day.
What are the key benefits of using a volume profile over traditional volume indicators
Using a volume profile offers several key benefits over traditional volume indicators:
- Identifies Key Price Levels: A volume profile displays the volume traded at each price level, allowing traders to easily identify significant support and resistance levels based on areas of high trading activity (high volume nodes) or low trading activity (low volume nodes). Traditional volume indicators do not provide this level of price granularity.
- Reveals Market Acceptance/Rejection: High volume nodes represent price levels where the market has shown significant acceptance, as a large number of trades occurred at those levels. Low volume nodes indicate price rejection, as market participants avoided trading at those levels. This insight into market behaviour is not readily available from standard volume bars.
- Highlights Value Area: The value area, typically representing 70% of the total volume traded, is considered the “fair value” range for the security. Prices outside this range are considered extreme levels. Identifying the value area helps traders gauge market sentiment and potential reversals.5
- Pinpoints Point of Control (POC): The POC is the price level with the highest traded volume, representing the area with the most trading interest. The POC acts as a magnet, attracting prices towards it, making it a crucial reference point for traders.
- Provides Visual Representation: The volume profile presents a clear visual representation of market activity across different price levels, offering a more intuitive understanding of market dynamics compared to traditional volume bars.
- Aids in Trade Planning: By identifying high-volume nodes, low-volume nodes, value areas, and the POC, traders can plan their entries, exits, and stop-loss levels more effectively, potentially improving trade management
Correlation between volume and price
When trading volumes, the previous price and volume trend is very important. When a movement takes place with a volume close to or above the average, this movement is more important than a movement with low volume.
When the price increases with increasing volume, the market expects the upward trend or strength to continue. And if the same move occurs on low volume, we can say that we should be careful and plan carefully for the next move.
Similarly, if the stock price falls while volume increases, the downward trend can be expected to continue and be extended. And if the same movement occurs with less volume, we should be cautious about the next phase of this movement. A similar interpretation can be made for Rangi markets.
Correlation between candles, S&R and volume
When a candlestick pattern indicates an important pattern(like any of these important single candlestick patterns), and this signal occurs near key support and resistance levels, combined with a matching volume profile, it significantly increases the likelihood of a successful trade.
In other words: The combination of technical factors and volume allows you to generate strong trading signals. Traders can benefit greatly if they notice it in time.
Also read: Introduction to candlestick figures – Individual candlestick formations
Supplement
Let’s briefly recap what we talked about in this article:
- Volume is one of the key indicators for understanding market trends.
- This gives a very strong boost to our technical vision of the market.
- When the market is trading with low volume, it can be said that small traders are involved in the movement.
- If the price increases with volume, we can expect the upward or downward movement to continue (and vice versa).
- And when the market is trading at a high volume, that is usually a sign that institutional players are participating in the market.
Frequently Asked Questions
How do you use a volume profile indicator for trading?
A volume profile indicator is used to identify trading opportunities in the market. It is a graphical representation of the volume of a particular security over a given time period. The volume profile indicator is typically used to identify trading opportunities in the market.
What is volume profile in technical analysis?
Volume profile is the change in volume of a security over a given time period.
How do you analyze a volume profile?
A volume profile is a graphical representation of the total volume of a substance in a given time period.