Value Area Trading Strategy – Does It Work? (Backtest)

Last Updated on January 27, 2023

One of the most important factors in trading is trading volume, as it represents the amount of buying and selling that goes on. One strategy that makes good use of trading volume is the value area trading strategy. What is it?

Value Area trading strategy is a method of trading that makes use of the volume profile (market profile) to identify the range of prices where the majority of trading activity occurred during a given time period. Traders see those areas as potential areas for buying and selling.

In this post, we answer some questions about the value area trading strategy, and we make a backtest

Introduction to Value Area Trading

Value Area is a trading strategy that makes use of the volume profile (market profile) to identify the range of prices where the majority of trading activity occurred during a given time period. The strategy is based on the concept of “value” in the market, which is the price at which most units of an asset were traded during a specific time period.

The value area is determined by calculating the range of prices where 70% of the total trading volume occurred. Traders can use this information to identify key levels of support and resistance, as well as potential areas for buying and selling. This strategy is commonly used in futures markets but can also be used in other markets such as the stock and forex markets.

What is a Value Area?

In the analysis of price charts, a value area is the price level at which most units of an asset were traded during a specific time period. Statistically, it is defined as the level where 70% of the total trading volume occurred during a trading session.

This percentage is used because 70% is a rough approximation of one standard deviation on either side of the mean.

How to Identify a Value Area

Value Area is determined by calculating the range of prices where 70% of the total trading volume occurred in a given time period. Traders use this information to identify key levels of support and resistance and potential areas for buying and selling. With a volume profile tool on the chart, it shows as the level with the most lateral shadow.

Here’s an example from Tradingview:

Value Area Trading Strategy

And in Amibroker, a monthly trading volume area looks like this:

Value area trading strategy backtest

Using Value Area to Generate Trading Signals

Value Area can be used to generate trading signals by identifying key levels of support and resistance within the value area, and then, looking for price action that suggests a breakout or reversal. Traders may also use the value area to identify buying and selling following a breakout. They can also look for pullback reversals from those levels.

Advantages and Disadvantages of Value Area Trading

Advantages of Value Area trading:

  • Provides a clear picture of the market’s value.
  • Helps to identify key levels of support and resistance.
  • Can be used to generate trading signals.

Disadvantages of Value Area trading:

  • Can be difficult to identify the value area during volatile market conditions.
  • May not be effective in all market conditions.
  • It’s based on historical data and may not take into account future events that could affect the market.

Common Trading Strategies for Value Area Trading

Some common trading strategies for Value Area trading include:

  • Buying or selling at key levels of support or resistance within the value area
  • Entering a long position when the price is at the bottom of the value area and exiting at the top
  • Entering a short position when the price is at the top of the value area and exiting at the bottom
  • Using the value area to identify potential trend reversals
  • Using value areas to determine potential stop loss and profit targets

What Timeframe is Best for Value Area Trading?

Value area trading is commonly used in intraday and daily timeframes; however, it can also be applied to weekly or monthly charts. The timeframe used will depend on the trader’s preference and the market they are trading. Intraday charts provide more opportunities for quick trades, while daily charts provide a broader view of market trends.

What Indicators Can Help Identify Value Areas?

Some indicators that can help identify Value Areas include:

  • Volume Profile: It shows the distribution of trading volume at different price levels, helping to identify areas of heavy trading activity.
  • Point of Control: It is the price level where most of the trading activity occurred during a given time period.
  • Market Profile: It displays the most traded price levels and helps to identify areas of support and resistance.
  • Volume-weighted Average Price (VWAP): It calculates the average price based on trading volume, helping to identify areas of heavy trading activity.

How to Place Orders Around Value Areas

Traders can place orders around Value Areas by:

  • placing limit orders at key levels of support and resistance within the value area
  • placing stop orders in anticipation of a breakout or to limit potential losses (stop-loss orders)
  • placing market orders based on price action around the value area, such as buying at the bottom of the value area and selling at the top

What Are the Risks of Value Area Trading?

Value area trading can carry the risk of false signals, as past price action does not guarantee future performance. In addition, the value area can change over time, which can result in traders using outdated information. Moreover, the value area alone may not be enough to make a trading decision, and traders should always consider other factors and use risk management strategies.

How to Manage Risk When Trading Value Areas?

To manage risk when trading value areas, traders should use stop-loss orders and position sizing to limit potential losses. They should also diversify their portfolio and not rely too heavily on value area trading. Additionally, it is important to maintain discipline and not let emotions influence decisions.

What Are the Benefits of Trading Value Areas?

Trading value areas can provide traders with a clear way to identify potential areas of support and resistance in the market. These are key levels where the market has found value in the past, which can be used to make trades based on the assumption that the market will continue to respect these levels in the future and reverse around such levels.

How to Analyze Price Action Around Value Areas?

Look for patterns such as breakouts or rejection of the value area. Price rejection can be in the form of reversal candlestick patterns, such as hammer/shooting star, engulfing, and dojis. You can also look for bullish or bearish divergences with momentum oscillators, such as stochastic, RSI, and MACD.

How to Interpret Price Action Around Value Areas?

Price action around value areas can provide traders with valuable information about market sentiment and potential price movements. A breakout above the value area high or below the value area low can indicate that the market is trending in that direction. Conversely, a rejection of the value area, where the price fails to break through the value area high or low, can indicate that the market is consolidating or reversing.

How to Adjust Trading Strategies Around Value Areas

Traders can use the value areas to adjust their trading strategies in different ways. They can use such levels to determine their stop loss and profit targets. They can also use the value areas to confirm or adjust their trading signals from other strategies.

Value area trading strategy backtest – does it work?

The value area trading strategy is not as easy to backtest as it sounds. Any backtest requires (of course) trading rules and settings to get statistics and performance metrics.

A search on the internet reveals that we would be the first to make such a backtest, though. But we pass….

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