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Volume Analysis

Volume Analysis

Trading Using Volume Analysis

This post will cover the basics of how volume can be used to help trade the financial markets.

Volume Analysis Overview

As retail traders, individually, we have no power to move the market.  Therefore, in order to understand what price may do next, we need to look at the footprint of “smart money”.  This entails looking for repeatable price patterns that show us how the institutional traders are positioning themselves.  Some people try to trade news events in order to attempt to trade with the “smart money” but often this will lead to losses as the professionals have “bought the rumor and sold the news”.

How do we follow the smart money?

The institutional traders are not in the business of trading to help others and they will do anything they can to gain an edge.  They do not want us to know what orders they have placed in the markets.  We can however gain an understanding of their positioning through the following:

  • Price action analysis.  This can be through the open, low, high and close of a given period of time.  i.e. 4 hour candlestick giving a 150 pip range on the GBPUSD Forex currency pair and closing near the ultimate candle high.  I cover this in my other tutorials and ongoing trade posts.
  • Volume analysis.  The subject of this post.  I will attempt to show how volume can be analysed and  how the data can utilised to trade the financial markets.
  • Commitment of traders report analysis.  Traders of spot FX have no volume indicators to reference which is representative of the entire market because trades don’t pass through a centralised exchange; speculators can, however, utilise COT data from the futures market.

How do I use volume to trade?

Volume is typically shown as a histogram at the bottom of your charts.  The higher the histogram level the higher the volume.

First of all there is bullish and bearish volume for us to consider:

  • Bullish volume is expanding the histogram level during an  upward move and diminishing on downwards moves.
  • Bearish volume is expanding the histogram level during a downward move and diminishing on upward moves.

It goes without saying that we should be looking for bearish volume when in short trades and bullish volume when in long trades.  It is not always so simple as looking for high volume when we enter a trade though (is it ever simple?).

Combining this information with price action analysis.

Bar/candle size and open, low, high and closing position in relation to volume analysis.

When we see a move from an area i.e. a breakout we want to see a rise in volume, but not a huge rise in the volume as this may be a combination of supply and demand represented in a single bar.  A steady rise in volume is the desired scenario for a straight forward continuation trade trigger.  If we have gone long at a breakout we want any subsequent retrace down bars to be on low volume – showing the professionals are not interested in taking price lower.

This goes back to the basic bullish/bearish volume analysis mentioned above.

Here are a few potential ways to utilise this volume information:

  1. Large volume when moving up into fresh highs can make some traders bullish. This can be a trap if no follow through on subsequent price action is evident.  A doji, or simlar candle showing lack of interest after high volume up moves, can be an indication of weakness.  This is price hinting that the market must be weak because if the high activity (high volume) had shown bullish intent, why is the market now reluctant to go up?
  2. If price is approaching a trend line and shows low volume levels there is a reasonable chance of a bounce rather than a breakout as professional money is not pushing price lower.
  3. When observing large bars/candles, as a continuation trade, accompanied by high volume readings we want the bar to close near the ultimate highs.  Otherwise the high volume could have contributed towards making the bar close lower.  This mid bar close with high volume can be useful as a trend reversal signal though.
  4. Small bars/candles making new highs/lows on high volume.  What has happened to all of the volume?  Why has price not printed a large bar despite of the high volume?  This shows us a balance of buyers and sellers is evident – which is not what we want when entering the market in a continuation scenario.  Yet again this is useful information if looking to catch a reversal.

An example trade using volume and price action analysis.

  1. The market moves up into fresh highs (black bars above) and volume (green bars below) starts to dissipate.
  2. Price then makes an impulse move higher taking out the previous highs but subsequently closes as a bearish engulfing bar.  The volume was obviously not all buyers as price could not close on the highs.   This gives us a scenario where sellers have potentially made up a significant proportion of the volume -therefore a temporary top could be in place and a profitable move lower on the cards.

volume chart

This has given us a common sense entry into the market utilising price action and volume analysis. 

An example trade using volume and trendlines.

  • Breakout of the trendline.  Price moves below the trendline on higher volume. This shows an influx of activity at the level – may well be institutional traders.  An aggressive sell could be placed here.  One point of note is that this breakout closed quite high up the bar which some call “stopping volume”.  I see this as a close below support on high volume though –  the bears took control of the market.
  • The next bar could have been an entry for more conservative traders as the bar closes on the low with high volume.

breakout on volume

The examples above give an introduction of how volume can be used in technical analysis trading.

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