Volumes are one of the most important aspects to look for in trading, even though it’s one of the most overlooked ones. Most traders don’t use volume, and most of the ones who do, don’t know all the ways volumes can help them. Volumes can tell you what you can’t find in prices, such as the relative number of traders that are selling or buying. In this article, we will see what differences between volumes exist and how volume trading can help you in better understanding market trends.
What Are The Differences Between Volumes?
There are two main types of trading volumes: trade volume and tick volume. But what are the differences between them?
This is the most common type of volumes. It is widely used to refer to the total amount contracts/shares traded in a given period.
Volume tells investors about the market’s activity and liquidity. Higher trade volume means higher liquidity, which leads to a better order execution.
In the Forex market, as it is a decentralized market, it’s impossible to keep track of the size and amount of all contracts traded in a given period. In this sense, as an alternative to trade volume, traders look for tick volume. Tick volume is the number of price changes in a time interval. The main difference is that tick volumes represent how many times the price changed in a given period, and not the real bid/ask volume. We assume that, if prices change 100 times in only 5 minutes, there’s higher activity than if prices only change 50 times.
In decentralized markets like Forex, tick volumes act as a good proxy for the real amount traded. Usually, the most price changes in a given period, the larger the number of transactions that exist. This would imply a higher volume. We made a study on the relationship between volumes vs. tick volumes, and turns out they are quite closely correlated. Check more here.
What Information Do Volumes Give Us?
Volume trading is a strategy that can be very useful since volumes can lead or confirm major price movements. Before opening a position, you may want to look at trading volume to see where the money is flowing to. Volume levels can also help traders decide what are the best times for a making a transaction.
High volume during a large price movement may signal the strength of the trend. Volumes may act as a leading or a laggard indicator. When there’s high supply volume during an uptrend or high demand volume during a downtrend, this may signal a trend reversal before the reversal actually occurs. On the other hand, high volume can also show strength and confirms price movements – it’s all about the context.
Volumes usually indicate what large traders are doing, namely if they are buying or selling. Large traders, as explained in this article, are the ones capable of moving prices. Therefore, the best is to be on their side and benefit from their actions. By looking at volumes alongside price action, you can identify if there’s higher demand or supply at certain points.
Volumes also allow identifying key levels of accumulation and distribution and congestion zones. These are zones where there are a lot of demand and supply and traders may face above-normal resistance. Price By Volume Indicator, which we explain below, can help traders looking for these key levels
How to Use Volume in Trading?
1. Trend Reversion
Many times we see volume spikes preceding price. A decreasing volume in an uptrend is usually a sign that it may be coming to a reversal. Traders should wait for a confirmation of prices to close positions or go short.
In the chart below you can observe how major moves in prices or price reversions were always accompanied by volumes higher than normal. An analysis of volume in this situation would help traders identify these movements of prices.
2. High volume with little price movement
This is another pattern that usually shows in the market when there is professional distribution going on. This action means that even though there is buying pressure from weak or hedging traders, there are professional traders selling, and thus they keep the price in a tight range. Many great bull markets in history ended up with this kind of pattern, which is most reliable when the market is at new highs.
3. Confirmation of a price movement
A rising market usually sees rising volume. Higher volume is a sign that the trend is healthy and likely to continue. Increasing price and decreasing volume shows a lack of interest and may warn a potential reversal. Traders may use this information to decide if they are going to open a position during an uptrend or if they prefer to wait given the low levels of volume.
Strong volume confirms a successful breakout. If the breakout occurs under high volume, this is a confirmation that traders are bullish/bearish and the price movement is likely to continue. If the breakout happens under low volume, this may signal a lack of interest and a higher probability of being a false breakout. Before opening a position, traders should look to volumes to understand if the breakout will be successful or if the buying/selling pressure is not strong enough.
Price By Volume
Trade volumes appear at the bottom of the chart. However, Price By Volume (PBV), also called Market Profile, is an indicator plotted on the vertical axis. The indicator shows how much is the trading volume in a certain price range. This information helps traders understanding where are the major congestion zones, as well as resistances/supports. This indicator is mostly useful in very short-term time frames, such as 1 minute. We already wrote an explanative article about this indicator, which you can read here.
The chart below shows the price ranges with higher volume. Traders should expect some resistance/support or congestion areas near these levels.
You can download this indicator here.
Go Further with VSA
These are only some well-known indicators used in volume trading. However, they do not give you important information like if there’s buying or selling pressure. By looking only at these indicators, you only have an idea of generic levels to pay attention to. A complete volume spread analysis implies looking at demand/supply patterns, to identify the best time to buy and sell. By knowing if there are many traders selling/buying, you can anticipate important price movements.
The Bottom Line
Volume is a powerful tool to analyze the market and predict where prices are likely to go. Traders should use volumes to see what large traders are doing and follow their lead since that usually is where the money goes. However, volume only provides insights and traders should not use it right away as trade signals. Prices ultimately confirm what volumes already said and vice-versa. Traders should always wait for a price/volume confirmation and only then open positions.
It’s a widespread notion that tick volumes don’t represent real volumes and so they are too unreliable to be used. This new article looks into the numbers to reach a conclusion about their reliability: