Value Area Forex Strategy: Trading the Value Area
The Value Area is a range of prices where the majority of trading volume
took place on the prior trading day. In specific, this area is the
range where 70% of the prior day’s volume happened. The value area is
approximately one standard deviation above and below the average highest
volume price. With this knowledge, there are specific probabilities of
market behavior we can understand to digest the value area. The value
area gives us an idea of where the smart money is playing ball and where
the institutions are guiding the market.
Like
other popularized strategies, I think this is useful to know. However, I
wouldn’t hold your breath on returns for this strategy in reality. I’ve
done some backtesting and can’t seem to reach the 80% that the authors
and evangelists of this strategy claim.
Being generous, I’m able to get
up to 65%+. It is, however, difficult to spot scenarios where the 80%
rule really kicks in for filling. I don’t doubt that accurately trading
the value area is profitable. It is a challenge to identify when the
trade is available and to execute on it appropriately.
Though I’m new to
the idea and perhaps a well-established system or algorithmic method
could perform well. If you can do so, I can imagine a world where the
strategy could play out in your favor.
80% Rule
The
80% Rule states that when the market opens or moves above or below the
value area but then returns to the value area twice for two half-hour
periods, there is an 80% chance of filling the value area. Reread that
if it didn’t make sense before you move on.
If
the market opens above the value area and does not return to the value
area this is a heavily bullish signal. However, if the market opens
above the value area and returns to the value area this is very bearish.
Similarly,
if the market opens below the value area and does not return to the
value area this is a bearish signal. If the market opens below the value
area but returns to the value area this is a bullish signal.
This return to the value area from an open above or below the value area is what satisfies the 80% rule.
This
rule works because it’s indicative of institutional pressure. When the
market opens above or below the value area and stays above or below,
this is a signal institutions are buying and it would likely be a fool’s
errand to oppose the activity of the smart money.
At
their core, the markets are simple. When there are more buyers than
sellers, prices go up. When there are more sellers, markets go down.
Understanding all of the factors playing into market behavior, however,
is mind-numbingly difficult. We can make some interesting observations
about the market based on the 80% rule. Simply put, resting inside the
value area is indicative of balance in the markets. There is a roughly
even amount of buyers and sellers and we’ll see an oscillation between
the highs and lows of the value area. Of course, we want to initiate any
buying or selling as close to the tops and bottoms of the value area as
possible with tight stops in place. If the price falls out of the value
area we can quickly stop out and save from further losses. If the price
follows the 80% rule we can profit off the filling of the value area.
In
this crude graph I show an example of trading the value area. We can
see an example where the price shot above the previous day’s average
volume and without a return to the value area we are best suited staying
out of this trade. The next day we see the stock trade between the
value area for the bulk of the day, following the 80% rule. You can see
the stock dropped below the value area and then returned to the value
area for two 30 minute candles; it performed this action twice. It
followed the 80% rule both times.
Whether
you’re trading this algorithmically and have programmed this trade or
are trading this manually, you must either program appropriate stops or
plan for appropriate manual stops. Stay disciplined and follow your
strategy; don’t let emotions guide your trade. It’s interesting to study
these various strategies and see how different strategies guide
traders’ daily activities. The more strategies we can identify and
create algorithmic systems and backtest for the better.
Conclusion
I
came across the strategy on a quant finance forum and was fascinated to
see how it was being used. I’m doing some programming to try and
automatically pull data and calculate the value area for a few stocks. I
might try to paper trade it or just track its performance in an excel
sheet. Either way, it will be interesting to see how it performs.
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