Enhance your entries with the Volume Profile

With a stock market like the current one, moving in all-time highs, artificially created and maintained by the Fed, with the latent threat of the second wave of Covid, and the slow economic recovery expected in 2021, some traders (like me), with the intention of having better risk management, are choosing to carry out mainly daily operations (day trades or scalping) or, at the latest, of a few days or weeks (swing trades), trading zone by zone, since they intuit a latent risk in an exaggeratedly overvalued market.

And it is known that day trading is a task that requires great precision. In this context, there is a very useful tool that can help us improve our intraday entry and exit levels, based solely on the volume of trades executed: the Volume Profile. It's different from others: any standard indicators only show volume at a time, but they will not display any information of volume in a histogram at a specific price, as this technical analysis tool does.

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, making that information visible to the trader at a glance. Volume at a price gives more useful information as it provides the price levels in which big players' action took place. You can see at certain price levels, the volume is very thick: this level indicates the accumulation of massive quantities. A very easy reading.

The data that is provided by Volume Profile is indisputable, leaving it to the trader to find creative ways to use it. And due to its dynamic nature, it can be especially useful as a tool to identify intraday trade entry and exit points

Below is shown the NVDA intraday 5-min chart, with the Volume Profile configure for 1-day, showing its typical levels of significance  Next, I explain briefly them and my favorite strategies.

Click to enlarge.

1. Point of Control (POC), the crucial level

The most crucial price level in any Volume Profile is the Point of Control. Is the price level with the highest traded volume. And mainly, is the level where big guys start there their positions, so it's an accumulation/distribution level for smart money. 

Strategy: The previous POC will serve as a stable reference point (as support or resistance) for a current trading session. So, a popular strategy is to extend it: often a price reaction is there in the next session, as support or resistance, waiting for the first touch on the POC. Therefore, during the retracement to the Point of Control, and in the rebound from it, there are good buying/selling opportunities, as shown in the drawing below, taken from quora.com.

2. Value Area (VA) works as a support/resistance level

Represents the range of price levels in which a specified percentage (typically 70%) of all volume was traded during the time period. Since this value area (and the POC) represent "high gravity" areas where participants have seen the most value, its upper/lower borders can be used as resistance/support levels, respectively.

Strategy 1:  If the price falls outside the VA, search for reversals, waiting for a low trading volume in resistances or a high trading volume for supports. Depending on your bias:

- You can be long, if the current price is below the POC.
- Or short, if the current price is above the POC.

Strategy 2: Used previous VA1 to analyze market behavior (trending or ranging), just extending it and comparing it with the next session's value area (VA2).
If VA2 is inside the previous VA1, prices will range inside it. If there is a shift between VA1 and VA2, it means traders want new prices, so it's a trend day, and it likely will continue.

3. High Volume Node (HVN): acts as a magnet for prices

Are peaks in volume at or around a price level: HVN can be seen as an indicator of a period of stability or consolidation. As with the POC, usually, there are a lot of trades (buys and sells) and the market stays there more time than usual in HVN levels, pulling prices as a magnet, over and over throughout the session. HVN are prices where the smart money is trading and often represent key areas of support/resistance: stronger S/R levels are aligned with larger HVN and are correlate with swings in price. 

Strategy: When price approaches a previous HVN a sustained period of sideways movement is expected. The market is less likely to immediately breakthrough that price. So, in a risk-reward strategy, it's a good level to set there a stop or target for an exit: as been attractive levels early, traders usually sell there.

4. Low Volume Node (LVN): prices move fast through it

Are the opposite. They are valleys (or significant drops) in volume at or around a price level. LVN is usually a result of a breakout rally or a breakdown, so when price approaches a previous LVN, the market is much more likely to rally through or bounce off of that price level.

Strategy: so, by definition, breakouts and pullbacks usually began at an LVN level... or pass it quickly! Depending on your bias, bullish or bearish, try this interesting move: 

- For a long trade use a buy stop in the first LVN level above the price. Place your stop-loss just below an HVN (to avoid get stop if the price reaches HVN and goes up). And align your profit-target with another upper HVN. 
 - For a short trade use a buy stop in the first LVN level below the price. Place the stop-loss just above an HVN, and the target on another lower HVN.

Finally, use these considerations in your day trading

The NVDA 5-min chart below resumes my Volume Profile strategies from daily trading. Check carefully it and verify how powerful is this tool, undoubtedly one of the best for define entry and exit levels. Due to its versatility, consider these strategies and check others, mainly for your intraday or scalping trades. 

My recommendation is to use it in a 5-minute chart in conjunction with your Price Action Analysis (using major timeframes to decide trends, draw trendlines, price patterns and key areas, as usual) and other few indicators: less is more in technical analysis.  In my case, I use only two: the VWAP for rejections only in a strong uptrend (not shown), and the RSI, for divergences at a key level, then confirmed by a trendline break and a candlestick confirmation

Click to enlarge.