Candle Volume Analysis.

First, the boring stuff, some basic points, 1) I don't want to get to hung up on precisely identifying the candle shape to much. So if I call something a 'hammer' and it might not be exactly 2 body lengths for the tail, then just adapt, be flexible and call it a hammer as well. 2) These set-ups using volume are not very reliable in consolidation, but then neither is conventional candle analysis so there shouldn't be any arguments on that. 3) I generally ignore Asian time zone, and have found these set-ups to work extremely well from early Europe open until NY early afternoon. This doesn't mean you shouldn't be trading them later in NY afternoon, just that with the Asian session taking over, and thin trading volumes, you could get whipped out of a good position due to crap time zone. 4) I generally use 30m ~ 4H and the examples below are extracted from those time frames. Sometimes I will go down to 15 minutes but as a general rule 1H charts may give 1 or 2 signals per session without spinning your head around as trading 5 or 15 m charts would. This provides plenty of opportunities for me, especially as I look through 20 odd currency pairs. 5) Establishing the Vol indicator is just using the volume indicator from MT4. Increasing volume compared to previous period is marked in green, and decreasing compared to previous period is marked in crimson. A number of colourful indicators are available freely, Better Volume, is probably the more famous, and popular to use. 6) This is not VSA, Volume Spread Analysis. Malcomb14 has a great thread at Forex Factory, called VSA with Malcolm which you can learn more about that particular method. I've studied it, but for me it makes things way to complicated, and the deference to 'smart money' is way to over blown. 7) My strategy, which is still a continuous learning process, is a simple idiots guide geared to adding success and understanding to various candle patterns, with particular focus on the entry and exits of harmonic patterns, using the best non-lagging indicator available, volume. The Basic Assumptions. Increasing volume on green candles is bullish. Increasing volume on red candles is bearish. How does volume help us to judge the potential value of a candle, or candle formation? If we compare the chart on the right. We have a green hammer turning up from a low, but volume has decreased, compared to the previous crimson candle, shown by the red volume bar.

The next chart on the far right has increasing volume associated with the green hammer when compared to the previous crimson bar.

So both are hammers, and potentially bullish signals, right? They are in similar positions, similar crimson candles prior, so we should expect, with all things been equal, a similar reaction to price to replicate itself. This does not happen as you can see from the next two charts showing the price action a few periods afterwards They move differently and the key is the volume.

The first chart with the bullish hammer, had a little rally, with a second hammer appearing. But notice that while the bars closed green, there has been a quite striking decrease in the volume. As our basic assumption says, increasing volume on green bars is bullish. As both green bars have decreasing volume then it is anything but bullish. The subsequent red bars confirm that supply is now greater than demand.

On the second chart the green hammer had significantly more volume than on the previous crimson bar. As we have two raising histograms of volume greater than the previous (both are green). This indicates that at this price point new activity has been encountered. What volume can tell us is which price point/level has generated an increase in trading activity. Volume doesn't actually tell us if buying or selling has hit the market. It only tells us if activity has been greater or less than the previous period, and in relation to previous periods of the day. The candles open and close help us to work that out if it was buying or selling, especially the subsequent candles and their volume.

Hammers together, another example. This shows quite distinctly how hammers can be refined into useful entry points for a trade on the back of volume confirmation.

At left we see the first green candle hammer, has quite less volume than the previous red candle (first blue lines). We can call this lack of demand (LOD) is confirmed by the following red candle. Our second green hammer, has an increase in volume, (second blue lines) and with it closing higher than previous close, it looks like demand has stepped in. Increasing volume on latter green candles confirms this. We can call this Demand Coming In (DCI)

The converse is used for bearish formations, and we use Lack of Supply (LOS) and Supply Coming In (SCI) to differentiate potential set-ups from false set-ups.

Live Trade Examples

a) Live Trade example. USD/CHF Monday 21 June 2011.

1) Early Europe open. Last closed bar is green and a hammer on increasing volume. Current bar is red, on increasing volume. The candle hasn't closed yet. We have become interested in this bar now to watch where it closes and the volume size.

2) Set-up The candle closes red, on increased volume compared to the green hammer. We leave a sell order below red candle low, and s/l just above the red bar (conservative traders could also use the daily high of the hammer as an alternative).

3) We have entry and market starts to drop on increasing volume. A few periods later we see a couple of green bars popping up, with a bullish hammer. Possible time to square up? Maybe. We have achieved at least 1.5 units of reward to risk. However as we know, only increasing volume on green bars is bullish, we know we haven't seen that yet. So trade alternatives could be just bring s/l to break even, or partial t/p and move s/l to above the wide spread bar. This is up to the individual trader.

4) As no bullish volume was seen, we now have price continuing lower on increasing volume. Individual traders can now trade the position according to their own degree of comfort. At these price levels we have RR >3.

b) Live Trade example. CHF/JPY Monday 21 June 2011.

In the set-up for CHF/JPY we see a higher volume (compared to previous) crimson candle hammer at (a) which is a bearish sign, increasing volume on crimson candles is bearish. However we have a higher volume green candle, closing near its highs. An entry order on the break of this candle enters us long. S/l goes under the entry bar, or the days low for more conservative traders.

Once we have achieved some upside move we must expect either, consolidation before up, or the move has stopped and we look to exit, or to turn and establishing a short position. As we see declining volume and the appearance of a red candles we should look to tighten up s/l, or partial t/p. At these levels we have 2:1 RR. As we have no increasing volume signs on red bars, showing there is LOS (lack of supply) then market moves up. At these levels we have around 4:1 RR and prudence would require securing the majority of profits at these levels, especially as close to ATR.

Trade walk through (1)

a) green candle on low vol b) green candle on slightly increased volume. Possible entry above here with s/l below days low hammer for aggressive trader. The candle after (b) would be another entry, especially with higher volume associated with it.Entry above it with s/l below or at days low red hammer. c) red candle with low volume, possible warning sign. LOS after c we have higher vol green candle. Possible entry point if missed the first two. d) red candle with increased volume (SCI) . Stop can be tighten to just under this candle. The green bar after (d) is green and widespread up with increased vol (DCI). e) red candle on increased volume, (SCI). Warning sign so stops should be tighten to here. Market moves above (e) and picks up volume. f) another red candle on increased volume , (SCI). Stops should be tightened just to below this candle. g) & h) show increasing bullish volume. i) we see another SCI red candle. Stops should be moved to under this candle. At (i) we could also enter a short position as we have an evening start formation on increasing volume.

(j) we see green bars, but decreasing volume, and red bar a little later to continue the bearish movement.

Trade walk through (2)

a) green candle with increasing volume. b) red candle with increasing volume (SCI). Entry at low of this candle. c) green candle with increasing volume (DCI). Potential warning sign that short positions might be in trouble. d) red candle with increasing volume, (SCI), and again confirmed by next candle (shooting star/doji gravestone), definite (SCI). e) red candle increasing volume, SCI f) green candle, with increasing volume, potential bullish signal. I would go long above a break of this candle. At a minimum s/l should be dropped to just above this candle. g) saves the trade, with WRB down, but not great volume. The increased volume with the following bar, doji, helps push market lower.

Harmonic Levels. The above trading was done on the back of simple volume studies. If there were a harmonic structure near our entry point then that would provide extra confluence. It could also provide different price targets. The above strategy can also be used as a defensive set-up once a harmonic position has been entered into, but which may not be performing as anticipated, and comes into resistances. Ideally one would establish the harmonic levels, and as they do now and look for candle confirmation, just by adding volume they should be able to sift through candle entries to find the stronger set-up. Volume also allows to see at what points obstacles to a successful harmonic price targets could be hindered. It is quite possible that you could swing trade both successful and failed harmonic patterns using volume. I still have more research to do in this area.