Volume is the only truly leading indicator. For a trader this means it is the only way of getting a glimpse into the future.
This is why professional traders use volume to interpret what the market is actually thinking, ahead of any move, allowing them to take advantage accordingly.
Volume tells us where the market is likely to go next, which for traders is all we need to know.
- Volume confirms the strength of a trend or suggests its weakness.
- Rising volume indicates rising interest amongst traders.
- Falling volume suggests a decline in interest.
- Extreme volume readings, i.e. climax volume often highlights price reversals.
- Points where the market trades on high volume are the points of strong support and resistance.
Breakouts and market spikes can be validated or ignored with the help of volume.
Volume Spread Analysis
In the 1930’s a trader called Richard Wyckoff took volume and analysed it until he had found a predictive indicator which he called Wyckoff volume spread analysis, or VSA for short. Many of the world’s iconic traders went on to use Wyckoff’s Volume Spread Analysis. Jesse Livermore and JP Morgan were amongst the many wealthy traders that used VSA to great success. Since then it has been acknowledged that VSA is an extremely good leading indicator, however, it has been superseded by a more powerful form of analysis called Volume Price Analysis.
Volume Price Analysis
My own trading journey began with VSA many years ago, and I was indeed fortunate. Many traders spend years struggling and losing money, before they finally discover the power of volume. Since then I have developed and built on this powerful approach analyzing price behavior which I prefer to call Volume Price Analysis or VPA.
This is the approach that I now teach in all my training rooms, for all markets including forex. Whilst is does take time to master, once learnt you will never look back.
However, for now, let’s go back to basics so that you can gain an understanding and an appreciation of why volume is used as the main indicator by professional traders. Then we can take a look at how VPA uses volume to gain it’s power.
High or Low?
Volume is the second most valuable item of data after the price itself. Large volume signifies that there are a large number of market participants involved in the price action, including financial institutions, who bring the highest turnover to the market. If the financial institutions are trading, it means they are interested in a price at certain level and they literally push the price up or down.
Low volume tells us that there are very few participants in the market, and that neither buyers nor sellers have any significant interest in the price. In this scenario no financial institutions will be involved, and therefore any moves from individual traders will be weak.
Volume and trend
Volume helps us to determine the health of a trend. An uptrend is strong and healthy if volume increases as price moves with the trend and decreases when the market moves into a counter trend. These are called correction periods or ‘pull backs’.
When prices are rising and volume is decreasing, it tells traders that a trend is unlikely to continue. Prices may still attempt to rise at a slower pace, and once sellers take control (which will be signified by an increase in volume on a down bar), prices will fall.
A downtrend is strong and healthy if volume increases as prices move lower and decrease when the price begins to re-trace (pull back) upwards.
When a market is falling and volume is decreasing, the downtrend is unlikely to continue. Prices will either continue to decrease, but at a slower pace or stop falling and start to rise.
Volume and reversals
When volume spikes at certain price levels, professional traders know that this is a clear signal of increased interest being shown by traders at that price level. If there is significant interest, as revealed by the volume bar, it means the level is an important one.
This simple observation of volume allows traders to identify important support and resistance levels which are likely to play a significant role in the future.
Where volume spikes are extreme, larger than any historical spikes, and generally called a volume climax, traders should look for clues from the price itself.
Single volume spikes alone can often bring the market to an abrupt halt. These extreme volume spikes often occur during fundamental economic announcements which occur daily. News can cause a spike in volume for a single day then disappear again.
Reversals, however, happen not over a single day but over a series of days. If higher than average volume stays in the market for several days a huge volume spike, a volume climax, will often signal a point of market reversal.
Volume and breakouts
Volume can help to validate all kinds of breakouts.
When the market is consolidating on low volume, an increase in volume can signify that a breakout is due. A breakout occurring on rising volume is a valid breakout, while a breakout with low volume is more likely to be false. Why? Simply because the lack of volume signals a lack of interest from the market and traders.
Trend lines and other breakouts are validated or voided in exactly the same way. So as you can see volume is without question the most important and powerful indicator of all. It is remarkably accurate at predicting future moves.
When you start to incorporate Volume Price Analysis in association with a volume indicator, you then have an amazing trading tool at your disposal.
The forex volume problem
Unfortunately forex volume cannot be measured as precisely as it is for equities, where every share traded equates to one on the volume bar.
Selling 200 shares means 200 in selling volume. In stocks the number of shares traded is managed and reported by the central exchanges, such as the New York Stock Exchange. There are many exchanges around the world that keep track of every share bought and sold, so it is relatively easy to get a precise measure of share volumes being traded on a minute by minute basis. The same is true in the future markets.
However, in the spot forex market there is no central exchange. We cannot count how many contracts or indeed the size of contracts traded at any given time. Therefore to count volume in forex it is the number of ticks or changes in price which is used, an from which we derive our volume.
One tick measures 1 volume. As a tick moves up and down volume rises. When volume rises, it signals market activity with participants actively buying and selling currencies.
From this analysis we can get a measure of volume with tick data, but how do we know if it buying or selling volume?
This is where platforms such as MetatTrader 4 and others step in. They provide forex volume free as part of the standard platform.
Now, for the first time, forex traders have the most important of all indicators available to them, VOLUME, and better still – its is FREE with the MT4 platform! If you would like to discover more about how I use VPA in all my trading, why not join me in one of my live training rooms.