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Introduction to Volume Analysis and Volume Indicators

Volume analysis is a handy tool to confirm price trends, reversals, and breakouts and get a snapshot of the collective behavior of all market participants. The following article is based on the book “Trader’s Book of Volume” by Mark Leibovit.

 

Volume can track the footprints of institutional market participants who often camouflage their positions. These dominant players include large investment firms, mutual funds, and hedge funds. Volume analysis can recognize the volume patterns of these key players and uncover their tracks.

 

IMPORTANT FACTS ABOUT VOLUME ANALYSIS

Volume analysis can be seen as a multi-dimensional map of the collective behavior of all market participants.

 

Why Does the Volume Analysis Matter?

By combining volume and price, traders can get a clear picture of what is happening in their market, more specifically:

• Volume can determine trend direction and confirm strong price movements
• Volume usually precedes price and tells traders how much conviction there is behind a market move
• Volume can identify potential trend reversals (divergences between volume and price can be seen as a sign of a reversal)

 

Linking Price and Volume

Volume analysis is capable of improving any trader’s predictive ability. These are some important facts regarding volume behavior:

• Volume can be used to analyze the direction, strength, and timing of all market trends
• Volume is an essential component of every price pattern
• Volume serves as a gauge of supply and demand and can signal changes in the general market sentiment
• Ignoring volume can cause oversights and formidable errors
• If a trader is unable to read or understand volume data, then he is forced into trading strategies serving the interests of the crowd

 

 

 

How Volume Confirms Price Movement

• A price move accompanied by strong or heavy volume is likely to continue in its current direction
• A price move accompanied by a volume lighter than normal may be canceled soon

 

Wyckoff’s Third Rule -Law of Effort vs Results

Wyckoff said regarding volume, that if there is an effort, the result must be in equal proportion to that effort. This means that if volume is the effort and price is the result, then these two variables must move in perfect harmony. Any disharmony between price and volume should be seen as a sign that something is about to change.

More Here: https://forexexperts.net/index.php/trading-systems/wyckoff

 

BASIC VOLUME/PRICE RELATIONSHIPS

Volume plays an important role in every significant price movement. These are the six basic Volume/Price relationships:

 

(1) Price Moving Higher/Lower + Expanding Volume

When the market is moving in an uptrend (higher highs/lows) or in a downtrend (lower highs/lows), an expanding volume increases the odds that the price movement will continue in the direction of the trend.

(2) Price Moving Higher/Lower + Consistent Volume

Price moving higher/lower with consistent volume is a sign that the trend should continue. Any action against the trend will probably prove profit-taking action and not a change of the market sentiment.

(3) Price Moving Higher/Lower + Contracting Volume

When the market moves higher or lower but the volume is contracting, it is NOT a sign of a confirmed price trend. In other words, the conviction behind the market trend is not strong enough to attract new participants. The absence of new money limits the odds of a trend continuation and a trend reversal is possible.

(4) Small Price Movement + Expanding Volume

When there are small price movements and the volume is expanding, it is an indication that countertrend forces are building in the market and the continuation of the trend is in jeopardy. Typically, this short-term pattern is seen in a trending market that ranges for a few days.

(5) Small Price Movement + Consistent Volume

A small price move with consistent volume is a sign that the market moves without a trend. This means buyers and sellers agree that the market is fairly priced at its current price range.

(6) Small Price Movement + Contracting Volume

When there is no price movement and the volume is contracting, it is a sign that buyers and sellers lack conviction that the price trend will continue. This pattern is often identified during a market consolidation phase, while new money is required to initiate a new trend.

 

Table: Summarizing the above relationships between price and volume

Price/Volume Relationships	EXPANDING VOLUME	CONSISTENT VOLUME	CONTRACTING VOLUME
STRONG PRICE MOVEMENT	Trend-Continuation	Trend-Continuation	Trend-reversal
SMALL PRICE MOVEMENT	Trend-reversal after a few days of ranging	Small-ranging market, fairly priced	Consolidation Phase until new money enters

 

THREE BASIC VOLUME PATTERNS

As mentioned above, volume is an essential component of every price pattern. These are some crucial volume-based patterns.

 

(i) Volume Confirming the Uptrend

In a healthy upward market movement, volume expands in the direction of the upward movement.

• Profit-taking may take place (pullbacks) which is characterized by generally small decreases in volume
• As profit-taking ends, new buyers enter the market, creating a demand imbalance (more buyers than sellers) and thus driving prices higher
• At this point, increasing volume confirms the continuation of the uptrend and shows that the prevailing price movement is in good health

 

(ii) Volume Confirming the Downtrend

This is the opposite pattern of the previously presented uptrend pattern. As the volume expands with decreasing price movement, the roles of buyers and sellers are reversed.

• Short sellers may take some profits and that may cause the price to correct upwards
• As profit-taking ends, new sellers enter the market, creating a supply imbalance and thus driving prices lower
• Increasing volume now confirms the continuation of the downtrend

 

(iii) Volume and Consolidation Patterns

Consolidation patterns involve price containment between a major support and a major resistance price level.

• The consolidation pattern will occur with a simultaneous pattern of volume contraction
• This results in some popular patterns such as triangle and flag patterns
• The consolidation ends when the price is capable of breaking out over support or resistance levels
• Volume should spike during a major price break-out
• Steadily increasing volume on sell-offs is typically a bearish sign, while spikes in sell-offs can be an indication that sellers have exhausted
• Increasing volume on pullbacks can be an early sign of a trend change

 

 

 

APPLYING VOLUME-BASED INDICATORS

 

Essential Volume-Based Indicators

These are some essential volume-based indicators for an effective volume analysis:

• A volume bar plot for quickly recognizing volume patterns
• A volume overlay such as a VMA as a leading confirmatory indicator (provides conviction behind the price trend, tops, and bottoms)
• A longer-term (macro) volume indicator to identify the direction of the master trend such as the “On-Balance Volume” provides a good read on the longer trend

» Find here all the important volume-based indicators: https://expertsignal.com/index.php/tutorials/volume-based-indicators

 

Volume Indicators and Timeframes

 

1. Longer-Term Cumulative Volume-Based Indicators

A longer-term cumulative volume-based indicator can measure the strength and sustainability of the overall trend. Longer-term volume indicators include:

• On-Balance Volume
• Volume Price Trend
• Intraday Intensity
• Accumulation/Distribution

 

2. Intermediate-Term Volume-Based Indicators

An intermediate-term volume indicator captures shorter-term price movements that can alert for upcoming trend corrections or reversals. Intermediate-term volume-based indicators include:

• Money Flow Index
• Force Index
• Demand Index
• Chaikin Money Flow
• Ease of Movement

 

3. Shorter-term Volume-Based Indicators

A short-term indicator can identify the time to either enter a position in the direction of the overall trend or attempt a trade against the trend. Shorter-term volume-based indicators include:

• Klinger Oscillator
• Percentage Volume Oscillator

 

4. Volume-Based Mas

If set to a preferred time frame, a volume moving average can alert for changes in the market direction for example by showing higher-than-normal volume with small price swings.

• A volume-based MA can indicate markets that are being either accumulated or distributed in a sideways action
• In a trending market, below-normal volume can signal that a shift in trend is imminent

 

■ Introduction to Volume Analysis and Indicators

G.P. for CarryTrader.com (c) -November, 18th 2024

Main Source: “The Trader’s Book of Volume” by Mark Leibovit