Insider Bars Basics: Value Area

The concept of value area is one of the most basic, and yet most important in volume profile analysis. From Markets and Market Logic, by Peter J. Steidlmayer (inventor of Market Profile):

In order to read market activity in the futures market, we will isolate, extract and categorize other timeframe activity, focusing in on and monitoring four portions of each profile:

1 – The value area and how it changes, both directionally and in terms of its high-low range. Monitoring this indicates how the market is facilitating trade. The range of value area as defined by 70% of the day’s volume and its location (higher or lower than the previous day) are illustrated in the lower left hand portion of each profile. This information is important when one is considering whether or not the market is facilitating trade. 

The definition is plainly stated: The central 70% of volume. This roughly corresponds to one standard deviation bands in a normal probability distribution:

Is there any profound academic reason why 68-70% equates to value? No. Yet markets have grown to accept this and use it. A similar situation exists in the world of options: Everyone knows that the Black-Scholes option pricing model is theoretically flawed, yet it is widely used in the marketplace.

Some people get confused on the meaning of value area due to a shortcut which was used to calculate it before real-time trade volume was available. (Before the 2000s, real-time futures data was based on individuals standing in the trading pits and reporting the prices of trades going on around them.) Volume @ price data was not available until the exchange settlement was completed sometime overnight. In order to have some idea of the value area during the trading day, a shortcut was developed. The following is from James Dalton et. al., Mind Over Markets:

Figure A-l illustrates how to calculate the volume value area.

  1. First, identify the price at which the greatest volume occurred.
  2. Then, sum the volumes occurring at the two prices directly above the high-volume price and compare it to the total volume of the two prices below the high volume price.
  3. The dual price total with the highest volume becomes part of the value area. This process continues until 70 percent of the volume is reached.

Note: This explanation was intended as a method to calculate value area based on volume. To get the original TPO formula, simple substitute TPO count for volume.

So the Market Profile value area estimate was 70% of the TPOs around the point of control. Based on TPOs ( i.e., time spend at prices), it is not a bad idea. The problem came with blindly substituting volume for TPOs. As we saw in the VPOC post, volume point of control is nothing like TPO point of control. TPO POC tends to be at a central part of the range. But VPOC can be anywhere. When using volume, the original estimating methodology is not a good one, and should be avoided.

There is no reason to use a formula to estimate value area when you can calculate it precisely using real-time volume data.

Value Area, both current period and prior period, can be used for support and resistance levels and for trend definition. The traditional value area was based on trading sessions. Insider Bars expands it far beyond that. Current options include the following:

  • Bar
  • Day (trading session)
  • Week
  • Month
  • Quarter
  • Year

Once you understand value areas, I think you will agree with me that they are among the most powerful tools in Insider Bars — or anywhere. Stay tuned for more posts on this topic.