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Chart Advisor: The Volume Profile Indicator

Chart Advisor: The Volume Profile Indicator

Posted June 7, 2024 at 9:29 am
Investopedia

By Shane Murphy, CMT

The Volume Profile Indicator

Investopedia is partnering with CMT Association on this newsletter.  The contents of this newsletter are for informational and educational purposes only, however, and do not constitute investing advice. The guest authors, which may sell research to investors, and may trade or hold positions in securities mentioned herein do not represent the views of CMT Association or Investopedia. Please consult a financial advisor for investment recommendations and services.

The Volume Profile Indicator

When a technical analyst evaluates a price chart, he or she will identify horizontal levels of supply (resistance) and demand (support). These levels will help the analyst determine trend, manage risk, and develop a complete view of the asset. One way to confirm if a price level is important and holds price memory, is to apply the volume profile indicator (VPI). Unlike traditional volume, which provides a temporal view of the asset’s relationship with volume, VPI ignores timeframe and reviews volume at specific price levels. In other words, instead of identifying the total volume of stock XYZ on this specific day, week or month, VPI tells us at what price the volume occurred. For this reason, VPI is presented as a horizontal histogram. The thought is that if a large number of shares are exchanging hands at a certain level, it is more likely this level holds true price memory and will behave as support/resistance.

The VPI level with the highest volume is referred to as the point of control (POC). The POC can be used to help confirm support/resistance levels. For example, the below chart highlights a liquid market index fund with a volume profile running from the October ’22 low to the Summer ’23 high. The POC confirmed the support/resistance zone ~$410 per share. Months later the asset successfully tested this support zone and witnessed demand bid prices higher.

VPI not only helps us identify support/resistance zones, but it can also aid our understanding of trend. When the POC is near the lower end of the profile amid what appears to be a healthy uptrend, we should reevaluate and ask ourselves why is volume declining at higher price levels? The below is a great example of an asset appearing to be in a strong uptrend, but the volume profile is not confirming the move higher. Eventually, price finds its way back to the POC and retests this level several times before breaking down.

The volume profile indicator provides a unique way to analyze supply and demand. Its application can vary depending on the asset or the analyst, but it remains an important tool in the technical analyst’s toolkit. 

About This Week’s Author

Shane Murphy, CMT has been a CMT Charterholder since 2022. He is currently a Wealth Management Associate at Michael Roberts Associates, Inc. where he assists in portfolio construction, investment research, and financial planning.

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Originally posted on June 7th, 2024

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