Volume Overview: How to Use Volumes for Trading | CFI VU
Volume trading

How to use volumes for trading


Volume is the fuel that drives the market. The volume reveals when the major operators are moving in and out of the market. Without volume, nothing moves, and if it does move and the volume is not in agreement, then there is something wrong, and an alarm bell ring! Although price is regarded as the best indicator of potential future price behavior, the volume offers additional evidence to corroborate bullish or bearish setups. Volume can indicate potential underlying weakness and also function as a timing indicator for potential breakouts. The relationship between volume with bar range also offers critical insights into the actions of buyers and sellers, especially when extremely low or high volume is accompanied

What is Volume?

Volume is the number of shares or contracts traded over a specified period in any trading market stocks, bonds, futures, and options. In the spot forex market, we have a different problem. There is no true volume reported but we use tick volume

What is tick Volume?

Tick volume is the number of recorded price changes, regardless of volume or the size of the price change that occurs during any time interval. Tick volume relates directly to actual volume because, as the market becomes more active, prices move back and forth from bid to ask more often. If only two trades occur in a 5-minute period, then the market is not liquid. From an analytic view, tick volume gives a reasonable approximation of true volume and can be used as a substitute. From a practical view, it is the only choice. Higher-than-normal tick volume at the beginning of the day implies higher volume throughout the day

How Is Volume Portrayed?

The most common portrayal of volume is a vertical bar representing the total amount of volume for that period at the bottom of the price chart. Figure 1 shows volume statistics for Apple Computer using this method. This method is simple and assumes no direct relationship between price and volume. It just displays the data

Volume statistics for Apple Inc.

Figure 1

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The relationship between price and volume

Volume is regarded as a supporting or secondary indicator of potential future price action. To confirm the trend. Volume should increase as price rises and decrease in any downside retracements in a preexisting uptrend (bullish volume action). Volume should increase as price declines and decrease on any upside retracements in a preexisting downtrend (bearish volume action). Volume is an indication of market participation

Decline and rise in volume

Figure 2

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When studying volume, the trader should always remember two basic principles which are:

1. A rise in volume indicates that market participants are interested in seeing the price go higher in an uptrend or lower in a downtrend and are willing to buy higher in an uptrend or sell lower in a downtrend to participate in the unfolding market action

2. A decline in volume indicates that market participants are losing interest in seeing the price go higher in an uptrend or lower in a downtrend and are more willing to buy lower in an uptrend and sell higher in a downtrend, if not exiting positions in the market. As shown in figure 2

Volume confirming a preexisting trend

Figure 3

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Volume characteristics change in bull and bear markets

Figure 4

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Volume Divergence

When price and volume patterns are compared, it is important to see whether they align. If so, the probabilities favor an extension of the trend. If price and volume disagree, this tells us that the underlying trend is not as strong this is called a volume divergence as shown in figure 3

Volume not confirming a preexisting trend

Figure 5

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Apple stocks and volume

Figure 6

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Coors 2000-2001 chart

Figure 7

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Aligent Technology 2010-2011 chart

Figure 8

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Volume Precedes Price

Technicians believe that volume precedes price, meaning that the loss of upside pressure in an uptrend or downside pressure in a downtrend shows up in the volume figures before it is manifested in a reversal of the price trend. Volume normally leads to price during a bull move. A new high in price that is not confirmed by volume should be regarded as a red flag, warning that the prevailing trend may be about to reverse

Volume leads price in an uptrend

Figure 9

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Volume Buying and Selling Climaxes

Buying climax also called blow-off occurs at market tops prices suddenly begin to rally sharply after a long advance, accompanied by a large jump in trading activity, and then peak abruptly. The buying climax candle often closes near the middle or the low of the candle. It is a good short selling opportunity and the high of the buying climax candle will be a strong resistance as shown in figure 6

Volume Buying and Selling Climaxes

Figure 10

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The selling climax occurs at market bottoms prices suddenly begin to drop sharply after a long decline, accompanied by a large jump in trading activity, and then bottom abruptly. The selling climax candle is often close near the middle or the high of the candle. it is a good buying opportunity and the low of the selling climax candle will be strong support as shown in figure 7

Using volume for trading

Figure 11

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Two‐Dimensional Volume Analysis

We may also analyze volume two-dimensionally via:

■ Volume by price
Volume by price identifies the total volume traded at each price level.
■ Volume by time
Volume by time represents the total volume traded over a specified time interval or period.

Two‐Dimensional volume analysis

Figure 12

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Volume indicator

Technical analysts have developed a number of the volume-related indicator with a different method of calculation, but whose indicator’s main purpose is to answer only one question is the current price movement supported by trading volumes or not?

1- On-Balance-Volume (OBV)

The daily data that is cumulated into the index is the volume for the day adjusted for the direction of the price change from the day before. Thus, it is the total daily volume added to the previous day’s index if the price close was higher and subtracted from the previous day’s index if the price close was lower than that of the previous day. This index is a cumulative sum of the volume data and is plotted on a daily price chart.

The idea behind the OBV index is simply that high volume in one direction and low volume in the opposite direction should confirm the price trend. If the high volume is not confirming the price trend, then the light volume in the price trend direction and heavy volume in the opposite direction suggests an impending reversal. Figure 7 shows the APPLE stock and the OBV indicator.

Apple stock and the OBV indicator

Figure 13

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2- Volume Oscillator

It is merely the ratio between two moving averages of volume. Its use is to determine when the volume is expanding or contracting. Expanding volume implies strength to the existing trend, and contracting volume implies weakness in the existing trend It is, thus, useful as a confirmation indicator for trend and for giving advanced warning in a range or consolidation formation of the direction of the next breakout. For example, if within the range, the oscillator rises during small advances and declines during small declines, it suggests that the eventual breakout will be upward.

Apple stock and volume oscillator

Figure 14

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3- Money Flow Index (Oscillator)

Another method of measuring money flow into and out of a stock is the Money Flow Index (MFI). It considers “up” days and “down” days to determine the flow of money into and out of equity. The MFI is an oscillator with a maximum of 100 and a minimum of 0. When positive money flow is relatively high, the oscillator approaches 100; conversely, when negative money flow is relatively high, the oscillator approaches 0. A level above 80 is often considered overbought and below 20 oversold. These parameters, along with the period, are obviously adjustable.

Apple stock and Money Flow Index

Figure 15

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If there is one level widely used by large institutions it is VWAP. Huge transactions seek to execute at the price level where the VWAP is found and that is why it has elevated its level of importance. The VWAP represents the average price of all contracts traded during a particular time period. It is displayed on a chart like a traditional moving average and its position varies as trades are executed. Generally, depending on the trading style, the VWAP of the session, the weekly or the monthly is used. The VWAP is used by institutional traders primarily as an average to determine the value of the asset at that point in time so they consider that they have bought low if the price is below and high if it is above. Institutions have taken the VWAP as a reference measure with which to judge the quality of their executions, hence its relevance and the fact that we treat it as an important trading level.

Volume Weighted Average Price

Figure 16

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