How to use a horizontal volume and raise trading profitability

HOW TO USE A HORIZONTAL VOLUME

What is a difference between a sportsman and a trader? A sportsman asks why volumes decrease and weight stays the same. And a trader asks why volumes decrease and price stays the same.

This article contains all information required for understanding what a horizontal volume is and how it should be used for raising trading profitability:

  • History of introduction of horizontal volumes;
  • Instruments for analyzing horizontal volumes;
  • Advantages and disadvantages of horizontal volumes;
  • Misapprehensions about horizontal volumes;
  • Chart examples.

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Volumes. Horizontal and vertical.

Professional traders use the volume indicator in their work practically without exceptions. They build their strategies of trading by volumes on the basis of analysis of its dynamics.

The volume indicator sums up trades executed at a stock exchange in terms of money, contracts, coins or shares.

The volume could be:

  • vertical. It reflects the amount of trades executed during a certain period of time. The vertical volume is shown, as a rule, in the bottom part of a chart as a bar chart.
    For example, if you view a Lukoil stock chart in one hour time frame, the volume would show the total cost of all shares, which were bought/sold during this hour.
  • horizontal. It reflects the amount of trades executed at a certain price level. The horizontal volume or, as it is also called, volume profile could be located both in the left and right parts of a chart (and some profiles could be located even in the middle of a chart, as it will be shown in the examples below).
    For example, if you view a gold futures trading chart with the horizontal volume indicator, then each level in the indicator shows the total cost of all contracts, which were bought/sold at this level.

Vertical volumes were used by traders as early as in the beginning of 20th century.

How to use a horizontal volume

The Picture shows the Richard Wyckoff chart of the year 1931. There is a bar chart of day volumes in the bottom of it. 

And horizontal volumes were started to be used much later.

History of introduction of horizontal volumes

Peter Steidlmayer introduced the Market Profile to the public in 1984 as a visual representation of the market movement by price levels over time. In principle, the Market Profile and horizontal volumes display the same essence – activity of traders at each price level.

How did Peter Steidlmayer build the Market Profile? Let us analyze the chart.

Market Profile

X-axis shows prices. Y-axis shows symbols that correspond with a time span (Steidlmayer offers to use 30-minute time spans), starting from the moment of opening of a trading session:

  • Symbol A means a period of time from 8:00 until 8:30
  • Symbol B means the next half an hour – from 8:30 until 9:00
  • and so on until the symbol L

Each symbol is called TPO:

  • Time;
  • Price;
  • Opportunity.

Picture 4 shows that the market opened at the level of 97 14/32 (the price uses fractions, that is – “fourteen thirty-seconds”) and went down to 96 4/32 during the first 30 minutes. Sellers dominated the market and the price went down. The market turned around and went up from 96 11/32 to 96 23/32 during the B period and buyers started to resist the pressure of sellers. The price initially went down to 96 7/32 but then went up to the level of 96 21/32 during the C period. The market turned around again and the price went down to the level of 96 11/32 during the D period. The day session ends with the L period when the price turns around and goes down from 96 30/32 to 96 13/32.

For better understanding of the approach, have a look at Picture 5 where a bar chart with 30-minute period forms the Market Profile.

Market Profile

After observing the Market Profile development directly at the Chicago Board of Trade, Steidlmayer made a conclusion that the market tends to come to the final denominator – the state of balanced distribution. In this case, the Market Profile takes the shape of a bell curve.

Market Profile

Bell center – area of high volume, which says that both buyers and sellers are satisfied, in general, with the price. This is a balance area with approximately equal numbers of buyers and sellers.

Correspondingly, the balanced market is a market, which found a fair price and trades are distributed around it.

Bell ends – areas of low volume, which say that the search for a fair price is going on.

Correspondingly, the imbalanced market is a market, which moves in a focused manner because it searches for a fair price. Steidlmayer calls this imbalance a vertical distribution. See Picture.

Market Profile

According to Steidlmayer, every time the market is balanced (developed), it is ready for focused movement (distribution). See Picture 3 for better understanding.

Volumes. Horizontal and vertical.

Steidlmayer had many followers who enhanced and interpreted his theory:

  • James F. Dalton – the author of the “Mind Over Markets” book;
  • Donald L. Jones – the author of the “Value-Based Power Trading” book;
  • Tom Alexander – the author of the “Trading Without Crutches” book.

Development of information technologies boosted the use of the Market Profile theory.

Modern instruments of analysis of horizontal volumes

Market Profile representation has evolved and transformed after introduction of electronic exchange trading and powerful software for market analysis. Computers became so powerful that they can compute horizontal volumes with the accuracy of one trade in real time.

This is how ATAS trading and analytical platform works like. If compared to similar software products, ATAS provides the biggest freedom and flexibility for horizontal volume researchers.

Basic functions of ATAS for working with horizontal volumes:

  1. Bar chart of horizontal volumes;
  2. Market Profile Indicator;
  3. Drawing object – the Market Profile;
  4. Horizontal candle volume.

Have a closer look at these instruments and get better acquainted with the Peter Steidlmayer theory.

Horizontal volume bar chart

Horizontal volume bar chart

Horizontal volumes are shown in the left part of Picture 6. As it was already specified, the Market Profile term could also be applied to them. Standard vertical volumes are represented under the price chart along the X-axis (red and green bar chart).

Volume (both horizontal and vertical) indicators could be represented in the ATAS trading platform not in the form of total volumes only but also in more detail – in the form of bids/asks, delta or trades.

Volume Chart

Delta shows a difference between directions of the trades. Purchases are shown green and sales are shown red in horizontal volumes.

At first glance at the trading day profile one could notice a curved shape, which does not resemble a standard bell. Steidlmayer called it upward imbalance. See Picture 8.

Market Profile

In trading terms, this is the upward movement of trading volumes. That is, the price range of RUB 124,000-132,000 on RTS (RIZ8) futures attracted the biggest number of buyers and sellers during the day. Take heed of the huge green candle at 14:40.

Horizontal volume bar chart

More than 55 thousand contracts were traded in this candle, which significantly outweighs average volumes. We will come back to this candle a bit later.

And now we will clarify what VAL, VAH and POC on the horizontal volumes mean. These are values, which are related to the Value Area. In order to understand what the Value Area means, let us see Picture 9.

Market Profile Classic

Value Area – is a price range, which contains 68% of the volume of executed trades. Why particularly 68%? The number is determined mathematically with the use of the normal (Gaussian) distribution (you can find more information in mathematics textbooks or Wikipedia).

area of high volume

We will get VAL, VAH and POC values if we apply root-mean-square deviations to the Market Profile.

  • VAL Value Area Low – the lower boundary of the Value Area. The key level of the price range and support level. When the price approaches this level, the trader focuses on the market behavior by horizontal volumes – whether the price would break the VAL level or would turn upwards. The VAL is RUB 111,590 in Pictures 6 and 7.
  • VAH – Value Area High – the upper boundary of the Value Area. The key level of the price range and resistance level. When the price approaches VAL, the trader focuses on the market behavior by horizontal volumes – whether the price would break the VAH level or would turn downwards. The VAH is RUB 113,310 in Pictures 6 and 7.
  • POC – point of control. This is the maximum value in the Market Profile. The POC in our chart is at the level of RUB 112,500, which, approximately, is the center of the big green candle at 14:40. As we mentioned before, the maximum volume was traded during the day here.

Let us go back to Picture 6. We can see that the price tested the Value Area High (VAH), which is RUB 113,310, three times trying to break through higher. But the buyers did not have sufficient strength and the sellers won the day. Candle tails at 15:00, 16:40 and 19:40 confirm severe fight at this price level.

False breakouts extend the Value Area. However, the price comes back to the POC level in most cases. The number of true breakouts is much smaller than the number of returns to the maximum volume level.

Visualization of three key levels (VAL, VAH and POC) provides traders with ideas for trade:

  • To open trades for retracement from extremum areas to the center of the Value Area and vice versa – from the center of the Value Area to extreme points. Examples: trades Nos. 3, 4, 5 and 6 in Picture 11.
  • To open trades for breakout of upper/lower boundaries of the Value Area. Examples: trades Nos. 1 and 2 in Picture 11.
VAL, VAH and POC

By the way, the ATAS bar chart of horizontal volumes has one more wonderful possibility – selection of an arbitrary period of time for building the Market Profile – Picture 12.

You set the boundary, from which the profile will be built – Start Position, and the boundary, to which the profile will be built – End Position. Both boundaries could be easily moved immediately changing the selected time period. See Picture

Volume Chart

This is very convenient for searching for the areas of the market transition from the balanced state to the state of focused movement and also for other studies.

Market Profile Indicator

In contrast to the horizontal volume bar chart, which shows the profile in the left part of the chart, the Market Profile indicator does it “below the chart” highlighting the profiles.

Market Profile Indicator

Picture 13 shows a 30-minute chart for gold (GCZ8 COMEX), which covers several trading days. The Market Profile Indicator is shown in pale pink color, representing the profiles of each day separately.

Let us study the chart. On October 8 and 9 the market was balanced in the range of USD 1,188.4-1,195.2 and, using the terminology of Peter Steidlmayer, was ready for a new movement. On October 10 the market opens higher than the Value Area High of USD 1,195.2, testing this support level, builds on it and proceeds to a progressive upward movement. In the theory of Peter Steidlmayer – we have a classical trend day.

One of the basic terms of Peter Steidlmayer in the Market Profile theory is Initial Balance. Steidlmayer uses this term to designate the first trading hour range.

Steidlmayer specifies 5 day types depending on the horizontal volume behavior in relation to the Initial Balance.

  • Trend day – the horizontal volume is distributed mainly into one side and the Initial Balance extends more than two times. An important specific feature of a trend day – the day closes near the extreme point of the extended range.
  • Non-trend day – 85% of the day range is formed during the first hour and the range, practically, does not extend. Initial Balance is narrow.
  • Normal variation day – the Initial Balance extends less than two times and the day closes near the maximum extension of the Initial Balance.
  • Neutral day – the range extension goes both ways and one side extension balances the other side extension.
  • Normal day – an insignificant extension of the Initial Balance could take place.

Based on these data, Steidlmayer tried to forecast probable development of the next day. However, further studies of Donald L. Jones did not confirm impact of the form of distribution of the current day horizontal volume upon the next day.

Now, let us have a look at Picture 14.

Market Profile Indicator

Initial Balances are marked with black dots in Picture 14. This concept was very important in 1980s when the electronic trading did not exist and the markets had very clear frameworks of trading sessions.

Nowadays, when the markets are global and some of them trade day and night, it is not always possible to determine the Initial Balance. Please, compare Pictures 13 and 14. The Initial Balance is more pronounced on the Moscow Stock Exchange (Picture 14) than on COMEX (Picture 13).

Two interesting regularities are connected with the Initial Balance:

  • the narrower the Initial Balance is, the bigger is the number of possibilities for its breakout. And the more extended the Initial Balance is, the bigger is a probability of location of prices within this range during the day.
  • 67% of the daily high/low falls on the first trading hour. In effect, it means that 67% of the current day price high low would fall on its first hour. We can also see verification of this theory in Picture 14.

The Market Profile Indicator has flexible settings and it allows building the Market Profiles with various time interval values, showing the bar chart distribution by volume, time, delta and trades.

An ATAS user can analyze the state of the market at various time intervals simultaneously by using the Market Profile in a combination with the horizontal volume bar chart, which we discussed above.

Picture 15 shows the progress of trading futures on PTC index with combined horizontal volumes. The trader can see:

  • the candle chart with the 5-minute time-frame;
  • the bar chart of the day distribution of bids and asks;
  • the Market Profile Indicator, which represents horizontal volumes during the hour period.
Market Profile Indicator

Drawing object – the Market Profile

The basic idea of Steydlmayer is that the Market Profile helps to detect periods of balance, from which the market, most likely, would start focused movement. The Market Profile has a bell shape during periods of balance. The Market Profile object of drawing from ATAS trading and analytical platform would help to detect this shape.

Volume Chart

In fact, it is a horizontal bar chart, which shows distribution of the volume/trades/time/delta by price during an arbitrary period of time. You need just to circle the required part of the chart with the mouse.

A unique convenience of this instrument is that an ATAS user can immediately analyze horizontal volumes of any period of time – from weeks and days to minutes and seconds. With the help of this instrument one can not only detect markets where strong movement is possible, but also accurately determine key areas (VAL, VAH and POC) for various periods of time within seconds.

Horizontal volume in the candle

Volume Chart

Picture 17 shows one week chart on gold (GCZ8 COMEX). We can see a balanced market, which is ready to move, on August 5. Movement starts on August 12. The market tests the USD 1,215.5-1,184 area and comes back to the state of balance during that period of time.

Market Profile Indicator

It is evident that the simultaneous use of several instruments – the horizontal volume in the candle and Market Profile object of drawing – allows analyzing the state of the market faster and more conveniently.

A positional trader could use horizontal volumes for trading at minimum risk.

  • Selling by a limit order from the Value Area High (VAH) of USD 1,215.5 – the order will be executed on September 9 or 16.
  • Buying by a limit order from the Value Area Low (VAL) of USD 1,184. The order will be executed on September 23.
  • Buying/selling by a limit order from the middle of the Value Area (POC) of USD 1,202.1. The order would have been executed during any of the considered weeks, since the price tested the area of maximum volume regularly and in various directions.
  • Buying at breakout of the Value Area High of USD 1,215.5. The order would have been executed on October 7.