Volume Technical Analysis
There is an age old saying in trading and that is that volume precedes price.

Volume can give an indication to the trader of how the price is about to react given general market interest in the asset. This is why it holds such an important status among technical traders.

Volume is also a really important metric as it allows these technical traders to know about the general liquidity that is in the market. Liquidity has a large impact on the price movement of the asset.

Moreover, volume is used as an input for a number of other technical indicators which are used to analyse trends. These include the On Balance Volume (OBV) and the Money Flow Index (MFI).

In this post we will go over volume based technical analysis and some strategies.

Buying / Selling Volume

When one has to think of Buying and Selling volume, it may at first sound confusing. Volume is transactions and for every buyer there will be a seller. Hence, how can there be Buying or Selling volume?

Of course, this is not helped by terms such as “Buyers are in control” or buying volume is exceeding selling volume. One should not read too much into these terms though.

Buyers are in control whenever the price is increasing and of course the opposite for when sellers are in control. Buyer volume is volume that occurs at the offer price. Seller volume is volume that occurs at the bid price.

Volume is displayed at the bottom of the chart with a number of vertical bars. These represent the volume that changed hands in that particular period. It goes without saying that red bars indicate that one had a price decline in the period and green bars show that we had a price increase.

In the below chart we have an example of volume. We have the price of Bitcoin Cash plotted with 1 hour scale.

Volume Chart Example

The bar charts below are termed the “tick” volume. As you can see, the colour of the tick volume corresponds with the colour of the candle.

Trading with Volume Strategies

As mentioned above, volume tends to precede price. Technical analysts will watch the volume in order to determine whether it is giving off any indication of potential price movements.

Volume also ties in with the concept of trader psychology. Traders are more inclined to join strong moves and less inclined to trade on those that are perceived as weak.

Although volume is a relatively simple concept to understand, when combined with the price and current trends, there are a number of different strategies that one can employ.

We will take a look at some of the most effective volume based technical trading strategies.

Volume and Trader Interest

Generally, a market that is increasing in price should see an increase in volume. This is because in order for a trend to be sustained, there should be more buyers who are willing to come into the market and pick up the asset.

Hence, when the price of the asset is increasing it is a bullish sign that the trend can continue if the volume is increasing.

On the other hand, when volume is decreasing while the price is still rising this is an indication that interest in the asset is beginning to wane and the trend could eventually lose steam and potentially reverse.

Taking a look at an example, in the below image we have USD/CAD plotted with 2 hour candlestick charts. We also have the moving average lines for the 20 and 50 period moving averages. This will give us a good indication of the trend.

Volume and Trader Interest

As you can see, there was a fall in the price of USD/CAD on increasing volume. This shows that selling pressure is strong and is indeed picking up. This is a bearish sign and the trader should have shorted the pair.

Hence as a general rule of thumb, trend strength is determined by what the volume in the asset is doing.

Exhaustion Points

Exhaustion points occur when volume immediately spikes in conjunction with a sharp change in price. These are signals of potential turning points in the trend.

The rationale of the exhaustion point is that those traders who did not want to miss the trend will immediately jump in and either buy or sell in a very short period of time. This leads to a spike in the volume and exhausts the remaining supply of potential traders.

Once there has been a spike in the volume, one will usually see a lower volume play out afterwards. This shows that the volume was indeed exhausted and that a reversal is around the corner.

In the below image we have the price of GBP/CAD plotted with 2 hour candlesticks.

Volume Exhaustion Points

As you can see, the price was trending downwards slowly on relatively stable volume. However, there is a large drop in the price of GBP/CAD which corresponds with a spike in the volume with selling pressure. This is an indication that the available sellers may have been exhausted and will not be adding to selling volume in the future.

Indeed we can see that the trend disappeared and the price of GBP/CAD remained relatively flat for the remaining few days.

Volume Breakouts

When the price is trading between a support and resistance level for a period of time, it is between a range. When the price immediately breaks through the support or resistance level then this is termed a “breakout”.

Volume is indeed very helpful for traders to identify those breakouts which are confirmed by general trader interest. When there is a breakout from a trend with low volume then this is termed a “false” breakout and should be viewed with suspicion.

If the price breakout is confirmed by an increase in the volume then this should be an indication to the trader that general market sentiment for the asset has been swayed.

Taking a look at an example, in the below image we have the price of copper plotted with 2 hour ticks. As you can see the price is remaining within a range defined by the resistance and support levels.

Volume Breakouts

There was a breakout from the range as the price broke through the resistance level. This was also on higher volume which confirms the breakout. Indeed, if the trader had placed a long position he / she would have profited from the rising trend.

Comprehensive Trading Strategies

In conclusion, volume is an incredibly important indicator of the strength behind an asset. It can help the trader to determine whether a trend is indeed driven by underlying market interest.

Even though volume is such an important technical indicator, it has to also be used in conjunction with other key technical studies. These include such indicators as the RSI or the MACD which help the trader to determine if a trend is approaching any turning points.

This is where indicators such as the OBV and MFI can be very helpful for the trader. They combine volume with other technical studies to give an all-encompassing reading of market movements and sentiment.