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Futures 4 Fun: Uncover Hidden Price Levels with Volume Profile

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July 5, 2016
volume profile overlay

Supply and demand. That’s about all there is to the price of a futures contract—it’s price discovery in the purest sense. No earnings calls, no share dilution, and no accounting assumptions. That’s what makes futures different from other financial markets.

Such unpolluted technical action can lead to patterns that repeat often and may become actionable. For example, members of the old Chicago Board of Trade (CBOT) observed patterns of price and volume in the 1980s that became a popular model called Market Profile. These observations inspired various studies of how futures volume (or lack of it) at certain price levels reveals whether buyers or sellers are in control of the market, and how this might be used to help estimate the direction of price movement.

The Volume Profile indicator is a similar study that’s available on the thinkorswim® platform from TD Ameritrade. There’s one major difference: Volume Profile displays volume traded at each price level, which makes it easy to see what price was traded most.

There are many ways to use the Volume Profile. To help get you started, consider the following two major keys that may uncover hidden inflection price points—volume distributions and volume nodes.

Volume Distributions

In a typical trading session, volume tends to be normally distributed—a fancy way of saying that when volume is displayed as a profile on the same axis as price, the shape at the end of an average session frequently resembles a balanced bell curve (see Figure 1, below). Most volume occurs in the middle of this curve, while relatively little volume occurs in the upper and lower tails.

volume profile overlay


The Volume Profile overlay on the price chart is bell shaped, which means most of the volume is traded in the middle of the bell and the lowest volume is traded on either end. Source: thinkorswim® platform. For illustrative purposes only.

This seems remarkable, because the shape of the Volume Profile during the session often changes fluidly. Sometimes it resembles a “p” shape, where a lower tail exists, but not an upper tail (yet). Sometimes it resembles a “b” shape, where an upper tail exists, but no lower tail (yet).

By spotting the shape of a Volume Profile during the session, and estimating the price at which volume must occur to make it normally distributed, you can estimate the direction of future price movement—information you might find useful.

High and Low Volume Nodes

Prices at which the highest and lowest volume occurs are also noteworthy. Volume indicates levels of acceptance (high volume) and rejection (low volume). Intuitively, when volume is high, the price is usually equally attractive to both buyers and sellers. At a price where fewer participants are willing to transact, volume must adjust quickly to find equilibrium.

Therefore, low volume occurs at extreme highs and lows, when the price is too high for buyers or too low for sellers. High volume occurs in between extreme highs and lows, at an equilibrium price.

Hypothetically, you might be better off buying at a low-volume node at a support level. When you do, you’re buying at a lower price than everyone else at the equilibrium price. Likewise, selling at a low-volume node at a resistance level means you’re selling at a higher price than everyone else at the equilibrium price.