Advanced Day Trading Strategies Using Volume Profile (2024)

Written by:
John McDowell

A Volume Profile is a volume-by-price trading indicator that shows the total trading activity or volume traded at each price level over a specified period. This contrasts the traditional and commonly used volume-by-time indicator that displays trading volume over a specified period instead of price level. Using the Volume Profile while trading can significantly improve your performance as you get a detailed and insightful view of the trading activity at different price levels.

In this post, we will learn how the Volume Profile indicator works and how to apply advanced trading strategies, which can take your trading to the next level.

The histogram is plotted on the chart after the system divides the total volume at a particular price level over the specified time into up-volume trades or down-volume trades. The trader can then easily visualize significant price levels by analyzing the histogram created on the chart. For example, the length of histogram bars indicates the trading volume at each price level over a specified range of time; the longer the bars, the higher the trading volume at that price level and vice versa.

To use the Volume Profile Indicator, you need to be aware of the significant levels or the components of the histogram displayed on the chart. Here we list and describe some of those:

Low Volume Node: As indicated by the name, a low volume node indicates the price level where the trading activity or volume is low. In other words, the price level at the low-volume node is of little interest to buyers and sellers, resulting in thin trading volume.

High Volume Node: The high volume node represents a high volume of trades at the particular price level on the chart. It means that the price level bears significance, which is why there is a high level of buying and selling transactions taking place.

Point of Control: This price level shows the highest trading volume, even above the high-volume node. The point of control area is the most significant as this price level draws the most interest from the buyers and sellers, resulting in peak trading activity.

Value Area: The value area represents the price range where a specified percentage of the total trading activity took place during a period. The percentage is typically set to 70%; however, a trader can set it to any value. The value area is used to determine significant price levels and support and resistance levels.

Depending on the trading platform, you can configure the Volume Profile indicator in various ways. For example, you can either choose to plot it at the bottom of the candlestick chart on the x-axis, or you can plot it right over the candlestick chart. Some platforms also allow you to plot the volume profile indicator horizontally on one side of the main price chart.

As discussed in the previous section, there is a high volume of trading activity at high-volume nodes. When most of the high-volume nodes are in the Value Area (usually 70%), the price level is significant and you can then look for price retracements, providing opportunities for trade setups.

For example, if the price enters the high volume node, you can expect the price to retrace from there as one party – either buyers or sellers – will prevail, which will move the price in their direction. Traders mostly look at the high volume node retracements at past price levels to predict future price movement. If the price indeed retraces, you can then consider setting up your trade at that point.

High-volume nodes are usually a resistance level when the price trades below it, while it acts as a support level when the price trades above it. Suppose, there is an uptrend and the price retraces to the HVN, it may be a buying opportunity as the HVN at this price level might act as a support level, from where the price usually bounces off.

The strategy could also work in reverse. For example, if there is a downtrend and the price moves up to the HVN, you can expect it to retrace as the HVN level at this point might act as a resistance, providing an opportunity to sell short.

You can set your stop loss just above or below the HVN, depending on whether you want to go long or short. If you want to go short, the stop loss would be placed just above the HVN, while it would be placed below the HVN if you want to go long and expect the price to bounce up the HVN after dropping. However, you should give your trade enough breathing room and not place the stop loss too close to the HVN so that you are not stopped from the trade too soon.

If the market is trading in a range and you observe the price continuously retracing between HVNs, you can use the distance between the next HVN as your take-profit point in such cases.

Low Volume Node is the zone where the trading volume has been low compared to the nearby areas. The LVN signifies a lack of interest from buyers and sellers which means that price moves rapidly at these price levels.

Because of low trading activity at the LVN price levels, the price doesn’t stay there for long, unlike the price at the high volume node levels. Resultantly, there is no resistance or support at LVN price levels and the price mostly slips from there until it gets support or faces resistance at some other price level. The LVN breakout strategy focuses on such low-volume areas to identify trading opportunities.

When the price nears LVN, it can present traders with a breakout trading opportunity as there is less volume to arrest the price movement at this level. So when the price breaks out the LVN, this could be an indication of the start of a new trend or a change in market sentiment.

You can enter the trade as soon as the price goes past or breaks out the LVN. For long trades, your stop loss would be just below the LVN, while for short trades, the stop loss should be placed above the LVN so that you don’t fall prey to a false breakout where the price bounces back.

While the LVN breakout strategy is quite effective, which can be verified by studying historical charts, it is best to combine it with some other technical indicators to increase your chances of making successful trades. These could be momentum indicators, RSIs, and moving averages. Since the price breakouts at LVN levels are quick yet significant, the strategy is particularly popular among short-term, day traders and scalpers looking for quick high-risk/high-reward setups.

The Volume Profile indicator is also used to determine trends in the market. This is done by analyzing the shape and structure of volume distribution over a period across different price levels, which gives vital clues about the current state of the market.

For example, if the histogram has a bell-shaped or normal distribution structure, the market is usually in an equilibrium or a range-bound state. In a balanced or choppy market, the price is centered around the Point of Control and Value Area of the Volume Profile chart.

If the market is trending, the distribution is skewed towards one side, indicating the shifting of the Point of Control and increased trading activity at the price level. The skewed volume profile distributions are classified into two types: P-shaped and b-shaped. The P-shaped volume profile distribution is wider at the top and thin at the bottom, signaling that the volume is increasing at a higher price level – a potentially bullish signal, or bearish signal if at a market top. In contrast, the b-shaped volume profile distribution is thin at the top while wider at the bottom. It shows an increase in trading activity at a lower price, which can be a bearish signal or a bullish signal at the start of a new trend.

However, before entering the trade, you should confirm the signal by using other trend indicators to increase your chances of making a successful trade.

Volume Profile helps traders identify key support and resistance levels. These are price levels where there has been increased buying or selling activity, with the price consolidating and finally reversing the ongoing trend.

For example, in an upward trend, when the price stops moving up due to increased selling activity at a particular price level, it is called a resistance level. Conversely, in a downtrend, when the price stops going further down and ultimately bounces back due to a sudden buying activity by buyers, we term this price level a support level.

The High Volumen Nodes (HVN) in the Volume Profile indicator mostly act as support and resistance levels since those price levels were marked by heightened trading volume. Because of the high trading activity at such price levels, breaking through these levels takes significant effort, due to which price retraces most often from there.

The Low Volume Nodes (LVN) in contrast are areas where trading volume is low, and hence the price doesn’t stay there for long. This makes LVN price levels a breakout or breakdown point – the price level where there is no support or resistance from either buyers or sellers. Such price areas provide opportunities for trading breakouts and breakdowns.

As discussed in the article previously, the Value Area also holds significance since it covers around 70% area of the total trading volume during a period. In a range-bound market, the Value Area High (VAH) on the VA often acts as a resistance level while the Value Area Low (VAL) acts as a support level.

No matter how confident you are about your trading strategy or the trade set-up, having a risk management strategy is the key to achieving long-term success in trading. One important element of risk management is the optimal trade size. If your trade size is too large, you might end up losing too much in case the stop loss is hit. In contrast, if your trade size is too small, you’ll be taken out of the trade too often as your stop loss would be hit frequently.

Backtesting the Volume Profile and playing with the historical data in different scenarios can make you feel confident while executing your strategy. You’ll instantly spot familiar setups once you apply the lessons learned from the guide. There's no better place to do this than in the TradingSim simulator.

Volume Profile trading indicator gives you a wealth of important information about the price and the trading volume driving the price. To successfully apply a Volume profile in your trading, you need to understand the important components of a volume profile, such as High Volume Nodes, Low Volume Nodes, Point of Control, Value Area, etc. These components reveal vital information that you can use to gauge the market sentiment and trade the market accordingly.

In comparison with the traditional volume-by-time indicator, the Volume Profile indicator is a handy tool that you should master. The indicator can be easier to interpret, and you can identify crucial price levels along with the support and resistance levels marked by heightened trading activity. It also helps you find low-volume price levels, where scalpers and day traders can find trading opportunities or to identify whether the market is trending or moving sideways.

Tags: Day Trading