Chapter 10: Value Area Trading – Part 1

Source: TradingView

Did you know? Value Area Trading was popularized by J. Peter Steidlmayer, a trader who worked at the Chicago Board of Trade. Steidlmayer developed the market profile concept, which is the foundation of Value Area Trading, in the 1980s. His work revolutionized how traders analyse and understand market dynamics, leading to the development of various trading strategies based on market profile analysis.

Breaking down the Value Area Strategy

• Value Area High (VAH):

  The Value Area High represents the upper boundary of the value area, which is the price range containing the majority of trading volume for a given period, typically around 70% to 80%. It signifies the highest price level within this range where trading activity is concentrated. Traders pay close attention to VAH as it serves as a resistance level, where selling pressure may increase, potentially leading to a reversal in price direction. If the market breaks above VAH, it could indicate a bullish breakout and the potential for further upward momentum.

• Value Area Low (VAL):

  Conversely, the Value Area Low represents the lower boundary of the value area. It denotes the lowest price level within the range where trading volume is concentrated. VAL acts as a support level, where buying interest may strengthen, potentially causing a reversal or bounce in price. Traders monitor VAL closely for signs of price action, such as bullish reversals or trend continuation patterns, to capitalize on potential trading opportunities. A break below VAL could signal a bearish breakout and the potential for further downward movement.

• Value Area Point of Control (VPOC):

  The Value Area Point of Control (VPOC) is the price level within the value area where the highest trading volume occurs. It represents the most traded price level during the specified period and serves as a significant reference point for traders. VPOC acts as a magnet for price, attracting trading activity and serving as a support or resistance level depending on its location relative to the current market price. Traders use VPOC to gauge market sentiment and identify potential areas of price equilibrium or imbalance. A strong deviation from VPOC could indicate a shift in market dynamics, with potential trading opportunities arising as a result.

• The blue and yellow histograms represent buy and sell trading volume, respectively.

Example

Here is a brief overview of how the Volume Profile can be used:

• Identify support and resistance levels

• Determine a fair price for the asset

• Predict potential trend reversals

• Determine if the market is balanced or imbalanced

We will use the VPVR (Volume Profile Visible Range) indicator which measure volume profile to understand the concept better.

Before spotting Volume Profile patterns, we need to adjust the VPVR indicator settings. Increasing the number of bars, such as to 150, provides a more detailed histogram, offering a clearer visualization of trading volume distribution.

Utilize the Point of Control (POC) line as support and resistance, and both high and low-volume nodes can also serve as support and resistance levels. High-volume nodes often precede a brief consolidation period due to increased trading activity.

The blue and yellow histograms represent buy and sell trading volume, respectively.

 

In the 4-hour chart of ITC with Volume Profile Visible Range (VPVR) indicator, observe the price breaking above the POC line (red line) on 13th June (refer the start of the yellow highlighted box), indicating a long position opportunity. The POC line acted as a support line. The price remained in an uptrend until surpassing the Value Area High (top blue dotted line) around 25^th July. Subsequently, the price retraces back to the resistance formed by the value area high and proceed in a downtrend towards the POC line. Subsequently, a period of consolidation followed, and the price started to move towards the resistance again in Dec.

 

 

If we look at the hourly chart, the downtrend that began on 25th July seems to be supported when the price first broke the Value Area High to proceed towards the POC line, which was also broken later, around August 18th, as shown on both charts.

Pro tip - The 80% Rule: The 80% Rule  states that if the stock price opens above/below the value area but retraces to the value area twice within two consecutive 30-min candlesticks, there's an 80% probability of the value area being filled. For instance, if the stock price retraces to the value area from above with two consecutive 30 min candlesticks remaining inside the value area, then there is a 80% probability of a downtrend till the value area is completely filled.