How does the Volume Profile work? – Tutorial

The volume profile in trading describes the traded volume in an underlying instrument at a specific price. Usually the volume is plotted on the time axis so that a certain value is displayed per candle and per time. With the volume profile, the price axis is used to calculate a specific number of contracts traded per price, for example, in FDAX.

This allows you to see which brands have a lot of trading activity and which have little trading activity. The point of greatest trading activity, that is, the highest volume traded per day, is called the point of control (POC). In addition, two further areas are often shown, which are defined as ValueArea (VA). Within this range, 70% of the daily volume is traded, if you take the default setting. Above the POC and below the POC, the ValueArea-Top (VAT) and the ValueArea-Bottom (VAB) can be plotted. A typical chart with a volume profile could then look like this:

Statistical Evaluations for the Volume Profile

In order to develop an automatic trading system or a trading strategy from this data, a statistical evaluation of the volume is required. Only then can you see whether it makes sense to develop a trading system and whether it is worth implementing it. In the following, the respective price levels of POC, VAB and VAT from the last day are used. The position of the opening price of the following day in relation to these values is considered. The current day cannot be considered because the volume develops over the course of the day and the POC and ValueArea are therefore constantly shifted until these values are fixed at the end of the day.

Trading approach from the volume profile for your trading

The following points (positions) of the opening price are considered:

A: Open of the day > POC, but Open below VAT

B: Open of the day < POC, but Open above VAB

C: Open of the day > VAT

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D: Open of the day < VAB

The evaluations were carried out from 2013-2017, i.e. over 5 years, in order to ensure a certain timeliness. Evaluations 10 or 15 years back are of course also possible, but in my experience the significance for today’s market is lower.

A total of 1249 trading days were considered in which the POC of the previous day was reached in more than 63% of the cases, i.e. was restarted. The ValueArea-Top was reached in just under 60% of cases and the VAB was reached in just over 54% of the days. This is in line with expectations, as we were in an upward trend during the period under review.

Here now the described cases A-D and the historical probabilities for them. The evaluations were created with NinjaTrader

Trading strategy for volume profile trading

Strong numbers that require implementation. However, the following points still need to be considered and this makes it difficult to find a systematic approach here. The evaluations do not yet say anything about a possible range of points or the points gap at the opening. Often it will be similar to the FDAX gap analysis that the margins to the respective levels are quite small. Most of the time these are 1-2 points, which can hardly be exploited with an automatic trading system. In manual trading, however, a reversal pattern or the confirmation of a strong candle could be waited for, so that a much better risk/reward ratio underlies here.

Conclusion on the volume profile in trading

The previous results show that it is definitely interesting to use the volume profile figures and the associated evaluations for your own trading. For the discretionary trader these evaluations are already very helpful and can protect against unwanted losses. Profit positions can also be better managed. If, for example, the price has opened within the VA, but below the POC and at 4 pm in the FDAX the price has not yet gone to the POC or the VAB, there is still an 80% probability of this happening in the last trading hours.

Automatic trading strategies are not yet so easy to create with these values. I would like to discuss further evaluations in part 2. These can include the time of day, trend definitions, or even the point difference to the respective levels. In part 3, a self-trading, fully automatic trading system is to be created in order to be able to use the results presented here for the volume profile.


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