Volume Profile & TPO
The volume profile is one study that I look at daily, but it is not a study that stays on my chart all day. The picture at the top of the page is set on a 5×5 (a 5-day 5-min chart) with each day showing it’s own profile. Another common setup is to set the profile over the entire chart – wrapping up everything into a singe profile.
The question is not about “which one is the better choice” – but instead it is about “what does each one do – and why should I use them both”? To answer that question better – it would help if we break the profile down into it’s individual pieces and components. Below is a picture of a 10-day volume profile on a 30 minute chart.
Another place which discussed the Volume Profile is TD Ameritrade; their article was amazing and certainly worth looking into (you do not need an account to visit the site and read their articles). If you want to check it out, just Click Here
Another Volume Profile article that is really good – is on TradingView. Here again, you do not need an account to read the article and their examples were great. You can read that article HERE
This 10-day 30 minute volume profile covers all the volume over the past 10 days and shows us a single profile in green (with a TPO profile in blue). This is a great example of how we can either “lay the profile” on the candles or we can set the profile on the side of the chart. Either way, it is going to measure the same thing.
Volume Profile
The volume profile has 4 main parts; VAL, VAH, POC, and Volume Bars. Some studies offer a few more things like “shading” and “high / low” lines but we can get into that later. The first thing we want to cover is POC (point of control) which is a line showing us where the greatest total volume was on the day.
Volume Profile is also called “Volume by Price” and that name is exactly what we are looking at: how much volume transacted at a price level. So, if the POC is where the volume was greatest (per price) then it is where the market traded the heaviest.
The VAL and VAH are going to take a few minutes to work through; they are the boundaries of a standard deviation (SD). To keep things simple here – we will just “short cut” & say that a 1SD is equal to 70% of all the volume traded (on each side of the POC).
The empirical rule, or the 68-95-99.7 rule, tells you where most of the values lie in a normal distribution: Around 68% of values are within 1 standard deviation of the mean (we do not use “mean” or “mode” within volume profiles) – we use “highest volume” and mark that as the POC.
STOP!!! Do NOT bail on me. Do not give up on your self. You do not ever have to calculate the math – you only need to understand what the math is calculating & I PROMISE you – this is NOT difficult. And I also promise you – that learning this concept of a standard deviation (SD) is going to help you understand SO MUCH MORE about trading EVERYTHING.
This is a “bell curve” – and the “x” is the place where stock prices are found. In trading, the “bell” would be on it’s side, but for now, we want to see it like this. This “bell” would cover every place that price went.
With a Volume Profile, the profile is this bell. The indicator is looking at all the volume traded and is shaping the “bell” to curve around that volume. So far, we have just been talking about the “bell curve” and this is an important subject we will come back to later.
For now, just keep with the understanding that you decide how much price to measure (in time) and the profile will measure it from the highest price point to the lowest price point. Where ever the volume was greatest – that is where the “peak” of the curve will be found (where the POC is located).
The profile shape above is a “classic bell curve” but as you can imagine, the POC of volume will not always be centered in the middle and we will not always have this “classic curve.” If we flipped this sideways, it would be how we use it on the charts.
The “curve” can be shaped like the classic D, but it can also be shaped like a B, P, b. Below, I have a few pictures that help us understand this better.
Here is a picture of $TGT – with a Volume Profile and the classic “D” shape. The “greatest total volume” is nearly centered and the profile is covering all the price on the chart. This is the same “bell curve” from the picture above, just flipped on it’s side.
Here, I flipped the profile onto its back. The candles are along the bottom and the volume bars are running up and down. As you would imagine, this is awkward, strange, and also hard to see.
We are not taught to look at stock charts this way & it makes little sense to ever really do it but for the purpose of “showing the bell curve” this is a useful exercise.
Here – I cut away price & I hand drew the “bell shape” over the volume. Even with my crude drawing skills, I think the “bell” stands out.
So, a Volume Profile is looking at all the volume traded within the timeframe you pick and then it plots a POC line where the volume was highest. Hopefully, your still with me & this is starting to make sense.
We can tell the study to look at minutes of price, or a day, a week, or anything really. We pick the time – how much time. The profile will show us where the trading happened and where it was heavy or light.
We can also choose to lay that profile on top of price or we can set it on the side of the chart but the study would not be different – just where it is sitting would be different. Some brokers give you the chance to use Volume Profile from the drawing tools, which means you can “pick out” an area and put a profile on it.
Value Area Low & Value Area High
Now that we have discussed what the profile is and we talked about the POC, it is time to discuss standard deviation which begins to get us into statistical math but again, we do not have to actually do any math; the study is going to do all the work.
We are going to focus on 1SD – since that is what volume profiles use. I can not encourage you enough – to learn more about statistical math outside of this article. It really will help you understand things in the trading world. HERE is a good (short) video that introduces standard deviation.
Within that bell above we have all the data & if we flipped it sideways with candles we would have all the candles within that bell. But our goal is not price, it is volume. We want to know where the volume was heaviest (by price).
A “typical chart” would have volume at the bottom of the chart & we would see big volume bars or small volume bars at various points through the trading day; that is good when we are looking for “when a lot of volume took place” but it is not very helpful for answering other questions like “at what price – did we get the most trading?
A standard deviation is a “slice” of some of the total volume traded; it is 68.27% to be exact (half above the POC and half below the POC). Within a volume profile, the VAL and the VAH mark the edges of the 1SD and within that range, we have 68.27% of all the volume traded.
So now, you hopefully understand the various parts of a volume profile; there is a POC & that is where the highest amount of volume traded (by price) and there is Value Area Low (VAL) and Value Area High (VAH) which marks the top & the bottom of a 1SD.
In the trading world, we most often use “napkin math” and round things – so a 1SD is considered “70%” just to save time and to keep things simple. So, 70% of all volume traded within that gold rectangle area in the picture above.
Earlier in this post, I discussed the various shapes that we can see using a volume profile; D, B, P, and b. Each of these shapes would still have a 1SD range with VAL, VAH, and a POC.
I hope at this point your starting to see that the Volume Profile is not actually calculating any statistical math – it is just using the “standard deviation” logic as a popular way to divide the volume. 1SD – this is where the majority of all the volume happened (or, where 70% of all the volume happened).
Thank you for sticking with me till the end of the article today – and thank yourself too for going out side of your comfort zone. In the next article, we will begin discussing the various settings for the volume profile.
I’m going to add more pictures below with captions that highlight POC, VAL, VAH, and distribution shapes such as the classic “D” – B – P – b.
Do not worry too much about these charts above – they are TPO charts but still use everything we discussed above (POC, VAL, and VAH) within a 1SD. In fact, now that you know “1SD” means “70% of… something” you can begin to understand a lot of other things (such as Bollinger Bands).
Michael is one of the best teachers I’ve seen after having gone through a lot of them. His approach to the market and his use of the VP opened my eyes to a different perspective. Thanks for this!