Technical Analysis

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 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:

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.

www.cmsfx.comNotice 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.

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