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Volume Based Indicators

Introduction

Volume measures the “worth” of a market move. If a currency pair has a strong price
move either up or down, the perceived strength of that move depends on the amount of
volume for that period. Moves backed by higher volume are more significant. By
monitoring volume, a trader should not be left behind on important market moves.
Important moves will usually come on a spike, or a short period of time when there is
more volume than normal. Volume can help a trader prepare for breakout from a trend.
Traders should also be able to identify periods where there are calm ranges and
consolidation as they will have lower volume.

Importance

Volume’s Significance:

Volume is important because when a large number of trades are placed in a certain day or
session, which means there are many buyers and sellers that set this price. Therefore, the
close for the session will be accurate since it is a consensus between the traders and
investors that are buying and selling. If volume was low, the price has been set by a
smaller number of individuals and organizations and may not be representative of the true
value.

Difference between Equity Volume and Forex Volume:

Volume is different in Forex than in equities. In equities every share traded is considered
1 volume, so selling 100 shares, and conversely someone buying those 100 shares counts
as 100 in volume. In Forex the market is decentralized and it is impossible to keep track
of all the amounts and sizes of contracts in a given day. Instead the way volume is
measured is to count how many ticks or changes of price there are throughout the session.
There needs to be a certain amount of contracts signed to move the price one way or the

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other, and each tick represents this amount. Therefore volume can still be measured, even
though it’s a little bit of a roundabout way compared to equities.

• Volume should be used as a corroborative evidence of a trend, not as primary


evidence.
• Volume can be used to confirm price changes. When a trend starts, and there is
not a pick up in volume activity, that may mean that the trend is weak and does
not have commitment.
• Secondly, if there is a pick up in volume, then that may mean that a change in
price may be approaching. The direction of the movement during this increase in
volume can be indicative of the upcoming action.

Who is in Control?

A bullish market is one in which there are more buyers than sellers. A bear market is one
where there are more sellers than buyers. When a majority of buyers move to seller
position, price drops. As price drops, more long positions switch positions to avoid
losses, bringing price down further. This snowball effect can cause a volume spike and
possibly a trend reversal.

Referring to long or short positions is easier than buying and selling as in Forex selling
one currency is buying the other and vice versa. To be in a long or short position on a
particular pair can only mean one thing.

Accumulation – is a term used to describe a market that is controlled by buyers.


If there is a downward trend that stalls when volume is increasing or high, that means
there are more buyers willing to buy the pair at the lower price and accumulation is
taking place. Once all the sellers are exhausted, then buyers will outnumber sellers and
the downtrend will reverse.

These are the two ways that a day can be characterized as accumulation:

1. Volume increases compared to yesterday and closing prices move higher.


2. After trending downwards, price moves very little on a pick up in volume.

Distribution – is a term used to describe a market that is controlled by sellers.


If there is an upward trend that stalls, and volume increases, that must mean that there are
many sellers willing to sell the pair at the higher price. Therefore buyers have lost control
to sellers.

These are the two ways that characterize a day featuring distribution:

1. Volume increases and closing price moves down.


2. After trending upward, price moves very little on a pick up in volume.

High Volume and Reversals:

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As mentioned before, volume can provide insights in trend reversals. In a longer term
scenario traders may be able to identify and ride trends. Reversals come about as there
are changes in the underlying fundamentals for a currency pair. Identifying these changes
is the real challenge of trading currencies. Usually as investors and traders catch wind of
these fundamental changes volume picks up as more and more investors get on board.

A reversal can be different from a volume spike, which is an increase in volume in a


single trading period. Reversals usually come on several to many days of higher than
average volume. The short-term extra volume needed for a spike can be brought about by
a single news item and its effects can wear off just as fast. Trend reversals are based more
on fundamental economic shifts and changes in the economies of two countries.

Notice how volume picked up dramatically at the end of 2004 after a two month
downtrend. The fundamentals between these two currencies must have changed and
traders responded, increasing volume at the market bottom. The downtrend buckled and
the USD/JPY went on a yearlong trend in the opposite direction. Most reversals will not
have such a big surge of volume, but this is a good visual example of how a reversal on
high volume can happen.

Trends move in waves with retractions. The lines labeled A-B-C try and show the main
parts of the wave for both the long term downtrend and uptrend. They are very
rudimentary and if one is interested, it would be beneficial to research Elliot Wave
Theory to learn about this phenomenon further.

Healthy Trends

Volume’s Significance:

Technical traders are always looking for good trends to trade. A position or swing trader
uses the volume indicator to try and locate healthy trends that they can “ride” for a month
or so. We will look at some past examples so that a beginner trader can get a feel for how
to use the interpretations of this very important indicator.

• An upwards movement is a strong trend if volume is increasing as price heads up,


and sessions where price decreases are associated with lower volume.
• A healthy downtrend would see volume increasing as price decreased and volume
decreasing on sessions where the price increases.

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There are three healthy trends that can be analyzed from February through May. Two of
two of them are uptrends and one is a downtrend. Even thought they are not very long
lasting, their progression will be covered more in depth coming up. In a general sense one
can see that in mid February price increased as volume trended upwards. In March, the
initial down move came on increasing volume. Lastly, after the downtrend reverses, the
middle of the following uptrend comes on increasing volume.

The first two healthy trends will be explored in figure 4; the third healthy trend will be
covered in figure 5. It should be evident that identifying trends, during trending market
situations such as the one in figure 3, can be very useful to a trader. You can see for
yourself the amount of pips that each trend moves.

Healthy Trends Cont.

Uptrend 1:

A. On Feb. 17th a period of uncertainty on lower volume ends. As price increases,


volume picks up. This holds with the diagnosis of a healthy trend.
B. The large blue candle on February 20th comes on high volume. After wards
volume declines as there are a couple of red candles. This behavior again holds
with the principles to start this section; those sessions in which the price goes
against the trend come on lower volumes.
C. As investors see that price is picking up again, volume increases before coming
down on the following two losing sessions (for a long USD/JPY position).
D. Again, price starts increasing and there is a move up in volume. As volume
increases here on March 3rd, the price activity is not a blue candle, but a red
stubby candle meaning there was a struggle between bears and bulls that didn’t
move the price much. This may imply that the uptrend is waning.
E. On the following two days, price goes up on decreasing volume, a truer warning
sign that the trend is weakening or ready to reverse.

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Downtrend 1:

F. After the up move tapers off, there is a red candle on lower volume. This is the
top.
G. Price begins to move down. As price falls faster, volume increases, meaning that
the trend is a healthy one. The moving average of volume is heading up during
this time, opposed to the flat shape it had during the second half of the uptrend.
H. The candle on March 18th is the biggest and has the most volume signaling
perhaps a market bottom. A large finishing candle on high volume is
representative of the end of a sell-off period.
I. There is a pause for the next two sessions, on lower volume, as there is a battle
between bears and bulls. The trend is not over however and continues from this
pause to head lower on increasing volume.
J. The lone blue candle comes on low volume, keeping in line with the tenets above.
The next day sees another huge drop, which is followed by a decline that does not
reach the low set in the previous session and on lower volume. Is this the end?
K. The next 3 days show a new trend forming as prices go higher on higher volume.

Uptrend 2:

L. After the initial burst of volume to change the momentum of the pair’s movement
from down to up there is a lull in volume, on a down day.

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M. During the next 10 sessions, volume picks up when price does, and volume starts
heading down when price decreases. We have a confirmation of the earlier market
bottom. April turns out to be a good month for the strength of the dollar.
N. The highest session of volume in this time period comes on a day with tight
ranges which means bears and bulls were fighting it out around an important level
at 109.50. The pair heads lower on two days of smaller volume, but as price picks
up so does volume.
O. There are 3 days of downward price movement on lower volume, before a big
break upwards on higher volume. The pair goes a bit further up before there is a
big battle over control between bears and bulls at the 114.00 level in late May.
The wrestling for control is important as it comes on high volume and reflects
many traders’ viewpoints that future direction is uncertain. In addition to volume,
the candles show this tug of war because they open and close between a small
range and the high and low wicks are rather big.
P. The bears win out here on the last day. On the same amount of volume as the
previous two days the price heads downward meaning sellers have wrested
control from buyers. Perhaps a new downtrend is starting, but the following two
red candles come on lighter volume which makes that presumption inconclusive.

Volume can help identify new trends or it can be used to monitor the current trend if a
trader is already on the right side of the price movement.

Unhealthy Trends

Trends on Decreasing Volume

• When prices are going up and volume is decreasing, this means that the trend is
unlikely to continue; prices will either increase at a slower rate or start to fall.
• When prices are decreasing and volume is decreasing, the trend is unlikely to
continue and price will either decrease at a slower rate or start to fall.

A. After an uptrend in March, April’s main feature in the USD/CAN currency pair is
an extended downtrend. It starts in the beginning of April around 1.1700. The
initial moves down come on strong volume, then there is a bit of retraction.
Volume picks up slightly on the next portion of the downswing, before pausing.

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Afterwards the last and third portion of the fall comes on even weaker volume.
Throughout the whole downtrend volume is decreasing. This is a classic example
of an “unhealthy trend” and it cannot last much longer.
B. The start of May shows a spike in volume as bears and bulls fight for control at
this bottom. The battle ends without a new direction at first.
C. On an increase in volume there is the start of an uptrend.
D. However as it continues, volume falls off and the currency turns down. We have
entered a time of consolidation.
E. Here again a slight uptrend forms on increased volume, but there is a fall as big
with high volume. A channel of resistance and support has formed in a true sign
of consolidation.

Volume can help identify new trends or it can be used to monitor the current trend if a
trader is already on the right side of the price movement.

Unhealthy Trends Cont.

Example 2: This example shows decreasing prices on decreasing volume:

• When prices are going up and volume is decreasing, this means that the trend is
unlikely to continue; prices will either increase at a slower rate or start to fall.
• When prices are decreasing and volume is decreasing, the trend is unlikely to
continue and price will either decrease at a slower rate or start to fall.

1. January 23rd sees a sharp rise on high volume. The rise may be an example of a
“buying/selling climax” of an uptrend. Isolated in this picture it is hard to tell.
From this top to the middle/end of February prices head down steadily.
2. After the spike up in price, the rest of the week is spent pairing those gains. The
sessions alternate between higher and lower volume, with the overall theme that
volume is decreasing.
3. There is a pick up on volume on the last day of January as Euro bulls try and stem
the downfall. Their attempts do not work, and price continues heading down.
Again this fall is on falling volume, a warning sign of a weak or “unhealthy”
trend.
4. At the end of this new decline the pair hits another low on February 6th. Volume
on this day is very low meaning that the price is not indicative of the whole
market and that fewer investors and institutions were responsible for its

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movement. The next day is a blue candle; volume picks up as more market
players enter and take back the Euros losses from the previous day. Volume
remains relatively high even though there is little movement until Feb 13th when
price falls sharply on higher volume.
5. From Feb 13th to the 22nd, volume falls sharply as there is uncertainty. Price
moves up and down in consolidation.
6. From the 22nd, volume (as can be seen from the MA) heads upward. After
initially heading down price start rising in a couple of big candles. Those gains for
the Euro are followed by two day days of losses, as investors have already
consolidated but now are trying to gauge which direction the next trend will be.
The Dollar’s recovery on a big volume day is not followed up with further
declines, and trading is lighter.
7. Next, the pair heads upward while volume increases. This is a good sign that the
preference of traders is moving in the direction of the Euro.

To add credence to the idea of this trend being an “unhealthy” one, it is important to put
this period of time into the larger context of the EUR/USD pair’s movements.

Unhealthy Trends Cont. 2

We were looking at the downtrend in early February. Let’s see what happens next.

It can be seen that the downtrend was not the start of anything bigger. Before hand there
was an uptrend, and afterwards the trend is upward as well. This downmove was likely a
correction and not part of a healthy new strong trend.

• When prices are going up and volume is decreasing, this means that the trend is
unlikely to continue; prices will either increase at a slower rate or start to fall.
• When prices are decreasing and volume is decreasing, the trend is unlikely to
continue and price will either decrease at a slower rate or start to fall.

8. Wavy uptrend: With the start of March volume picks up. Down moves come on
decreasing volume and the upswings come on higher volume. Volume ebbs on
Easter.
9. After the Easter holidays, price heads up again on increased volume, starting a
fast paced uptrend. At first volume decreases in divergence from the price action
which could be construed as a warning sign. The smaller ranges here mean

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investors are unsure that the wavy uptrend is over. However, volume starts
picking up as price continues heading upwards meaning traders are getting on
board the trend.
10. Volume gets higher as price increases reaching and going past 1.2900. The
torrential uptrend comes to an end with the appearance of a huge red candle.
There is high volatility and large ranges (though decreasing volume) as investors
try and figure out which way the next price movement will go. There is a drop of
volume for Memorial Day.
11. Traders are still uncertain and battle further. Once price reaches resistance from
the last high at 1.2900 there is a correction. Fundamentals shift here as the Fed
sounds very hawkish due to high inflation numbers. The move downwards
happens on increased volume.
12. Then it cools and so does volume. The rest of June has a downward trend in
volume because of uncertainty and traders waiting on the FOMC meeting coming
that week. The announcement from the FOMC meeting on June 29th went against
the markets expectations and the result was a sell off of Dollars on increased
volume.