Uncover Hidden Price Levels with the Volume Profile

August 31, 2023 Advanced
Here we'll review two ways the Volume Profile study on the thinkorswim® platform can help traders uncover hidden inflection price points.

The Volume Profile indicator on the thinkorswim® platform displays volume traded at each price level, making it easy for traders to see what price a security traded at most often.

There are various ways to use the Volume Profile, but for this example, we'll discuss how traders can observe volume distributions and volume nodes using the Volume Profile study.

Volume distributions

In a typical trading session, volume tends to be normally distributed, meaning 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 chart below). Most volume occurs in the middle of this curve, while relatively little volume occurs in the upper and lower tails.

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, traders can estimate the direction of future price movement.

Volume profile overlay

The Volume Profile overlay on the price chart is bell shaped. This means most of the volume is traded in the middle of the bell, and the lowest volume is traded on either end. The overlay is seen on a daily chart with green and red candlesticks.

Source: thinkorswim platform

For illustrative purposes only.

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). 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 usually occurs in between extreme highs and lows at an equilibrium price.

Hypothetically, a trader might attempt buying at a low-volume node at a support level. This means an attempt at buying at a lower price than everyone else at the equilibrium price. Likewise, selling at a low-volume node at a resistance level means an attempt at selling at a higher price than everyone else at the equilibrium price.

With a general idea of how Volume Profile works, a trader can potentially make more effective strategy decisions.

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