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Identifying & Trading the “Value Area”

Saturday, May 29th, 2010

Value Area from Market Profile

Most market profile identify an area where price and trading is very efficient. When using the word efficient, I mean that a proportionally significant number of contracts, shares or time have been transacted at this price level, causing numerous small non-directional movements in price. In general, we want to avoid the participating in these small non-directional movements which are basically "noise".

This range or bracket of efficient prices is called the Value Area. Value Area is defined as the range where 68%, one standard deviation, of the volume of the session being profiled occurred. The highest boundary of the value area is known as the "Value Area High". Similarly, the lower limit is the "Value Area Low".

In the market profile shown above, value area is indicated by the red box.

As I said earlier, the environment inside the Value Area is not good for intraday trading itself. But over the years, I learned some techniques for intelligent trading inside of Value. I’m not a hugely active day trader. I’m much more of a swing trader, but when I take a day trade, it almost always involves the Value Area in one way or another. Let me explain…

Setups Involving the High & Low of the Value Area

High and low value of the Value Area is very unique in that they act as extremely good support and resistance. While the price action of trading in the value area not smooth or particularly directional, a breakout above the high value of the Value Area or breakdown below the lower value boundary usually leads to an explosive, tradeable movement.

Similarly, price testing these levels may result in rejection more often than not, especially if it is the first test. This can also be used for your benefit when I trying to position yourself in the market.

Breakout/Breakdown Trade

It’s one of my favorite market profile scenarios to trade. Firstly, I always trade looking at the value area of the previous trading session.

If I see a breakout above the high Value Area range or a collapse below the Value Area low, I wait to ensure the market is accepting the new price range. I try to enter the trade on a pullback or retracement. Ideally, I would try to get in right at the boundary area of high/low value. I then set my target equal to the nearest pivot point or other source of support/resistance.

Here is recent example that worked perfectly. Before opening the spot market, the S&P futures broke below the value area. The market traded sideways accepting the breakout.

I was looking to sell at the first retest the lower value level. However, price did not trade significantly below the lower value level, and after making a higher low around 2.15pm moved decisively back into the Value Area and gave a small pullback/retest of the lower value level.

I bought on the retest, with my stop three points below. My first price target was the point of control level, which was about 6 straight points away, and the second target being the Value Area High 15 points away.

I took profits on my second target in just over 2hrs from my initial entry time.

 

 

 

 

 

 

 

 

The key with this setup is to be extremely patient. Perfect setups like this one come around 3-4 times a week and when they do they are easy to trade. The trick is not getting too aggressive at the wrong times.

Reentry into Value – the 80% Rule

My other favorite market profile setup involves trading a breakout or breakdown that involves reentering value area. This works especially well when the range between value area high and low is wide.

Often times the market will open up above or below value area. It’s not uncommon for the market to reverse its trend and break back into value. If this occurs, and prices confirm the movement by spending at least 20 minutes in value area, prices will proceed to the other extreme of value about 80% of the time.

For example, if the market opens above value area and breaks down beneath value area high, I start my stopwatch. If it spends at least 20 minutes in value area, I would look to get short. I usually try to enter within 0-3 points of value area high or low. That minimizes my risk should I be wrong – I can just put my stop 1 point above the edge of value area.


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