How to Read Volume Profiles in the Forex Market?
What is a Volume Profile?
There are two ways to observe the total trading volume in any market. As a point forex trader, you can tap into tick volumes as an accurate visual representation of the total trading volume on the X-axis, which will then base the analysis time. Alternatively, you can run your volume study on the vertical Y-axis, in which case you analyze total activity against price levels. What volume profile is this second study; It is a histogram of the quantities traded at certain price levels as opposed to certain times.
The volume profile allows any trader to evaluate market content to follow the never-ending auction process. That's what a market is at the end of the day, it's a continuous process of negotiating to find equilibrium/reconciliation (through the accumulation of transactions at a certain level) and what is perceived as too cheap or too expensive. The art of reading the volume profile is all about studying the anatomy of market auctions.
Before I take things to the next level, let me run you through some of the basics. When charting your volume profile, you should be intimately familiar with the following values:
1. Point of Control (PoC): Refers to the area with the most traded volume activity on the chart. This is the most relevant area you want to track, as it can help identify the placement of your stops or areas on the chart where you can find the most pristine entry levels. We'll call the busiest volume area the PoC or Checkpoint for a given period of time, and you'd be surprised how many times it acts as a wall in a retest. Traders tend to consider this an area of support or resistance.
2. High-Volume Nodes (HVN): Subsequences with high-volume activity in the graph. While not as strong or symbolic as the PoC, HVN is also a strong space as it represents increased trading activity.
3. Value Area (VA): The range of price levels where a certain percentage of all volume is traded. By default, industry standards tend to be 70%. When I explain the scatter curve principle below it will become much clearer why the default number is 70%, carry it with me.
There are three different volume profiles you can use in your charts. The first time you search for the volume profile option via the commonly used chart package trading view, the options include:
- Fixed Range
- Visible Range
- Session Volume
Trading the markets requires constant interaction with your charts, especially if you are an intraday trader. You are constantly looking for areas where you can rely to perform certain actions. Right? This first fixed range option allows you to select any area on the chart to parse the total activity. This is a tool that can be invaluable if you want to tighten up or track your stops and also identify the areas you are most interested in to enter your positions.
Let's say you want to play short on the EUR/USD 30m chart after the breakout of the range. A fairly traditional strategy would be to wait for the price to drop below two horizontal support levels and go short on a retest of one of them. The next logical question would be: where would you put your stop? If you're trading conservatively, you're probably placing your stop somewhere above 1.16 to have enough wiggle room in case it rebounds back into the rebound range. However, if you think about it, there are other areas of the chart that it still makes a lot of sense to take advantage of. If you are interested in tightening your stop to a size where your short trade can benefit from the possibility of a much greater risk-reward, you can leverage the power of the fixed range volume profile to determine what price level it is after the break. the highest volume concentration occurred. You can then use this as relevance to assist your action as a seller.
As the name suggests, the visible range option removes as much trading activity as the data on your chart. It provides the big picture view of the most traded price levels over a given period of time. This option is best suited as part of your daily or weekly analysis to identify areas of interest on the chart. By stepping back and projecting an eagle image from the macro level, it helps you easily identify key supports and resistances, which is essentially what I recommend using the visible range. By zooming out your charts, the macro is choosing your interests. Once done, you can start drawing horizontal rectangles on each high-volume node (black) or low-volume node (red). The highlighted areas will be the most relevant areas that you will want to pay attention to going forward.
While the volume profile options above are very powerful on their own, I don't agree that anyone can beat the ability to read daily auctions. The auction process in the last 24 hours of trading provides a roadmap for you to plan your next trading day in advance. If you are looking for answers to these questions at the end of trading in New York: Which side is in control? Do buyers/sellers accept higher/lower levels? Which side is stuck and therefore has a higher chance of recovery? All these questions and many more can be answered through the session volume profile.
If in the last 24 hours, the negotiation process ends with no party in control of the price action, this is represented on the chart by the formation of a belly-type curve. At the extremes, you can clearly see volume contracting, which means prices are exhausted amid a lack of sufficient liquidity to find equilibrium. The dynamics of price discovery suggest that price must return to the mean to find new bidirectional business/acceptance levels. This structure leads to what is often referred to as a range market. If you think beyond traditional technical training, establishing a range is nothing more than testing and disagreement at higher or lower levels.
The market will constantly seek new prices up and down. However, what really matters is not whether a level is tested, but rather the ability of market forces to accept it, thereby creating value. The thicker the volume on the Y-axis of the histogram, the more value is created as buyers and sellers agree on the new interest for business. So, let's address the key question. How can we prepare to trade these structures the next day? When presented with a single distribution, ie with a range, the areas of interest will include the endpoints of the range or alternatively the party under the control of the POC (Control Point).
In most cases, when we end up with a single distribution structure, the POC for that day will approach the 50 midpoints of the day's range. This is not a coincidence, because one of the properties of a single distribution is that it has a bell-principle symmetric structure or a normal distribution curve.
One of the key lessons learned from the 4 Pillars training in Forex involved the relevance of the bell curve, which is one of the foundations behind statistics and probability theory. It's also important to understand you as a trader if you're going to dig deeper into researching volume profiles. Note that one of the natural laws of statistics is that when we increase the repetitive trials of random events from tossing a coin, the results result in a more pronounced skew towards the center of the map or the bell shape. This is known as the central limit theorem. This is exactly what is involved when we see the single distribution structure in the volume profile. Our ordering activities from books, for which supply or demand is the prerequisite for not creating enough imbalances, are increasing.
As the volume continues to increase by the number of times N = the number of times a new order arrives (a person - human or algos - gets a trade), the shape becomes more apparent with the creation of another universal truth in statistics, namely standards. deviations. This indicates that more than 68% of the volume will add up under 1 standard deviation (blue), while 95% of the volume will be within 2 standard deviations (red). Now you will understand why the standard market value of a volume profile tends to be 70%.
As part of dual distribution structures, there are up to 4 subcategories we can classify. Each of these structures reveals the possibility of a different price pattern expected the next day.
Critical factors to consider when evaluating multi-distribution structures include the number of bold areas in the histogram (value generated) and the closing price. There is a strong dependence on where the price will close at the end of the NY session to assess the next day's play.
Following the EUR/USD example, the pair's pricing in the next 24 hours formed a double distribution structure. As part of this formation, we now need to categorize what type of structure it is based on where most of the volume is traded, as illustrated by the POC (Point of Control).
On October 24, the price was spent only a short time before the sell-off, leading to a series of low-volume bars in the histogram. As the dust settled, buyers and sellers began to agree on the next equilibrium level around 1.14, the daily low.
All the top buyers that facilitated value creation are now trapped, meaning any backlash against the POC makes it an interesting proposition to add short, especially if it aligns with the underlying trend. Unlike the Short L-shape, this Short P-shape tends to see a larger rebound as market participants cannot find enough two-way business at the bottom. Eventually, it leads to exhaustion before a potential recovery (anticipated recovery) in price as part of the market's price discovery mechanism.
Once this pattern occurs, a continuation lower without a prior recovery risks exhausting and trapping late weaker sellers unless there is a substantial increase in value at these newly found low prices.
These market dynamics are one of the strongest for the continuation of the ultimate trend. If we decipher the clues behind the auction process through the volume profile, it clearly shows that the market is accepting the low value. The fact that most of the volume has accumulated at the lows, and most importantly, that the price is closing at the lows of the day near the POC, is a strong indication that the market is not interested in taking profits.
Therefore, any potential rebound will likely see sellers determined to contribute to their short positions. This is a pattern that risks resulting in shallow recovery before the trend resumes.
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