Since I’ve been using volume profiles (VP) to assess markets, I have made one observation amongst others which I believe can give you a great idea of context and that all important indication of what might happen next. Before I continue however, as this is my first post on VP I’ll briefly outline how I understand it to be useful. VP is not an indicator. It’s also not a tool to create magical levels which always work! It is a way to better interpret context and then build upon it to identify and place value upon new context. It is the “framework” or “construct” around which you may build your understanding of trading activity and price action. And with that esoterically ambiguous definition, I’ll get to my rather more practical point!

Levels Activated for Context

Simply put, there are always current market levels or interesting price points, which a market wants to test (note that I’m not necessarily suggesting to buy or sell these levels) in order to gain better context. So for example, if a market 1-ticks (takes out an extreme by a single tick then reverses – indicating potential short-term exhaustion) its prior session high, a retest of the current session midpoint might well give more clues to how weak the test higher was. The price immediately preceding the release of an NFP report which was way out of line with analyst expectations (hence moving the market considerably in one direction) is likely to be key to any short-term reversal’s chances of being sustained.

An Auction is an Auction is an Auction

The market can be in one of two fundamental states at any one time. It can be balanced and in agreement on value or it can be imbalanced in price discovery mode in search of an agreement on new value. Action can be horizontal or it can be vertical. This is a universal truth about any market and the wording above is crucial to the idea I wish to share. I’ll warn you now – this is not rocket science. If the market is balanced then it is accepting of value and there are prices which are “unfair”. Therefore a market in a balanced state is likely to react to these prices and less likely to be bothered by perceived value. Conversely, an imbalanced market is “search of an agreement on new value” and by its very definition it’s looking for prices where value can be found.

Composite Logic – Back To Volume Profiles

In terms of VP, low volume nodes (LVN’s) are places where agreement on value has been less discernible in the past and high volume nodes (HVN’s) are places where the idea of value has been rather more abundant. This does not necessarily mean that markets will react at these prices again but it does mean that whatever does happen can better indicate the market’s intentions – Balanced markets often react more to LVN’s and imbalanced markets often react more to HVN’s. The exercise is therefore, to define important volume nodes to frame activity and identify the fundamental market mode. I’ll go over this in another post at a later date. If you’re familiar with long-term or “composite” profiles (composite of many other daily profiles), the volume nodes on these can often be useful to watch as I’m sure you’ll already realize. But if you already know what you’re looking for before the market gets to a level, depending on how it behaves when it gets there, you’re better able to decide how/if to trade subsequently.

Balanced markets often react more to LVN’s and imbalanced markets often react more to HVN’s

Importance of Qualitative Observations

Now I’m not sure how testable this observation is. Well, I know it’s manually testable, but it would take a lot of work. Whilst I’m not saying that this wouldn’t be worth it, I don’t have the time to undertake this right now. But at some point my knowledge, skillset or time availability might allow me to do a useful quantitative study. Not only this, but by constantly thinking about how the market trades and challenging your own understanding, you might learn a great deal and stumble upon some really interesting ideas. This being said, I was hoping to demonstrate how a little bit of Excel can be really useful in testing ideas. So I’ll just have to improvise instead. In my next post, I’ll take a look at how you might go about testing the idea of how likely the ES is to return to its developing VPOC upon rejecting its prior session VPOC.

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