Trading Terms

Volume trading: A step-by-step guide for beginners

Skilling Writers Team
2023-10-17
- Trading
- Education

Volume trading: complete guide to mastering market volumes

Picture yourself standing at the edge of a bustling trading floor, surrounded by the electrifying energy of traders shouting orders, the flickering screens displaying intricate charts, and the constant hum of transactions echoing through the room. Amidst this chaos, volume emerges as a beacon of information, whispering tales of buyer and seller interactions, revealing hidden trends, and providing invaluable clues about the future direction of prices. Welcome to the world of: volume trading. Below, we will unravel the mystery behind this powerful trading indicator and delve into its inner workings. We will explore the fundamental principles that underpin volume trading, how to use it and its advantages.

What is volume trading?

Volume trading is a strategy used by traders and investors to analyze the trading volume of a particular security, such as stocks, commodities, or cryptocurrencies, in order to gain insights into market trends and make informed trading decisions. It involves studying the number of shares or contracts traded during a given period of time e.g. during an hour, day or week.

When analyzing volume, traders tend to pay attention to the amount of trading activity occurring in relation to the average trading volume. This information could provide valuable clues about the strength or weakness of a price movement and the level of market participation.

To illustrate this with a real-life example, let's consider a scenario involving a stock called XYZ Inc. Suppose you are monitoring the trading volume of XYZ Inc. shares over a specific period, such as a week:


Monday:	The trading volume for XYZ Inc. is relatively low compared to its average volume. This suggests that there is less market participation and interest in the stock. The price remains relatively stable throughout the day, indicating a lack of significant buying or selling pressure.
Tuesday:	The trading volume for XYZ Inc. surges significantly above its average volume. This spike in volume indicates increased market activity and heightened interest in the stock. Traders and investors take notice of this volume surge as it may indicate a potential price movement.
Wednesday:	The price of XYZ Inc. starts to rally, supported by the high trading volume from the previous day. This suggests that buyers are actively entering the market, driving the price upward. Traders who pay attention to volume may interpret this as a bullish signal, indicating a potential upward trend in the stock's price.
Thursday:	The trading volume remains high, and the price of XYZ Inc. continues to climb. This further reinforces the bullish sentiment and confirms the strength of the upward movement. Traders who consider volume trading may view this as a confirmation of their bullish bias and may choose to enter or maintain long positions in XYZ Inc.
Friday:	The trading volume suddenly drops back to average or even lower levels. This could indicate a potential weakening of the bullish trend. Traders who rely on volume analysis might interpret this as a sign of decreased market interest and participation. It could prompt them to reconsider their positions or take profits, anticipating a potential reversal or consolidation.

In this example, volume trading allowed traders to gauge the level of market activity, identify potential trends, and make decisions based on the strength or weakness of price movements. By combining volume analysis with other technical indicators and fundamental analysis, traders could develop more comprehensive strategies and improve their chances of profiting in trading.

Advantages of volume trading

It helps traders in analysis: Volume trading provides valuable insights into market dynamics and helps traders analyze the strength or weakness of price movements. By studying trading volume patterns, traders may better understand market trends, identify potential reversals or continuations, and make informed trading decisions.
Better trade decisions possible: It allows traders to make more informed trade decisions. By considering the trading volume alongside price movements, traders may gauge the level of market participation and the potential impact of buying or selling pressure. This information may help traders assess the overall market sentiment and make decisions that align with the prevailing market conditions.
Observe the trading volume of other traders: It also enables traders to observe the trading volume of other market participants. By analyzing the volume data, traders can gain insights into the behavior and sentiment of other traders. This information may be useful in understanding market dynamics, identifying potential trends, and assessing the level of interest or participation in a particular security.
Provides more information than a normal candlestick chart: While candlestick charts provide valuable information about price movements, volume trading adds an additional layer of information by incorporating trading volume. By combining volume data with price patterns, traders can obtain a more comprehensive view of market activity and make more accurate interpretations of market trends and potential price movements.
Recognizes large orders in the market and thus interesting prices: Volume trading allows traders to identify large orders in the market. When there is a significant increase in trading volume, it may indicate the presence of large institutional or retail orders. Recognizing such orders may provide insights into potential areas of interest for market participants and help traders identify price levels that could attract significant buying or selling pressure.
Analyze how the market reacts to low and high volume: By studying how the market reacts to low and high trading volumes, traders may gain insights into market behavior. For example, during periods of low volume, the market may be characterized by reduced liquidity and potentially higher volatility. Conversely, high volume periods may indicate increased market activity and potentially more reliable price movements. Understanding these dynamics may assist traders in adjusting their strategies accordingly and making better-informed trading decisions.

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How to use volume trading

The volume profile and the footprint chart are the two most widely used tools for volume trading.

The volume profile is a graphical representation of the volume traded at different price levels during a specified period. It provides a visual depiction of the distribution of volume across price levels. The volume profile typically appears as a histogram or a series of horizontal bars on a price chart. Each bar represents the volume traded at a specific price level. By analyzing the volume profile, traders can identify areas of high volume (indicating significant trading activity) and low volume (indicating less trading activity) to gain insights into support and resistance levels, as well as potential price areas of interest. It helps traders understand the concentration of trading volume at different price levels and can be used to identify key price zones and potential trading opportunities.
The footprint chart on the other hand provides a detailed view of volume activity and order flow at each price level. It displays the volume traded at bid (buy) and ask (sell) prices, allowing traders to analyze the intensity of buying and selling pressure at specific levels. It presents volume data in a vertical format, often using color-coding or other visual indicators to represent the buying and selling activity. Traders can observe how volume accumulates or distributes at different price levels in real-time, providing insights into market sentiment and potential price reversals or breakouts. By studying the footprint chart, traders can gain a deeper understanding of the interaction between buyers and sellers at specific price levels and make more informed trading decisions based on order flow analysis.

It's important to note that volume trading is applicable only to assets that are traded as future contracts. When it comes to CFDs, real volume data is not available since they are over-the-counter contracts. However, traders can still trade CFDs and analyze futures prices within the software, as they exhibit the same price movements. A reputable broker ensures that CFDs (contracts for difference) are always linked to suitable futures contracts.

Here's what to consider:

Establish the data feed for trading volume and obtain real-time data: To engage in volume trading, you need access to real-time trading volume data. This involves setting up a data feed from a reliable source that provides up-to-date volume information for the specific market or security you wish to trade. Real-time data allows you to analyze volume patterns and make timely trading decisions based on the most current information.
What costs can be incurred in volume trading?: In volume trading, there are potential costs involved. Firstly, the volume trading software itself may come with a cost, as specialized software that incorporates volume analysis features may be required. Additionally, accessing the required data feed for real-time volume data may also involve subscription or usage fees. It's important to consider these costs as part of your overall trading expenses.
Selecting a broker for volume trading: Which broker should you choose? When it comes to executing volume trades, you have a couple of options for choosing a broker. One option is to use a future broker if you are specifically trading futures contracts. These brokers typically provide direct access to the volume trading software, allowing you to execute trades seamlessly within the same platform. Another option is with a forex/CFD broker such as Skilling.

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Volume trading and volume analysis

Volume is a crucial element in technical analysis, second only to price data. It represents the intensity and strength of price movements and is an essential component of comprehensive technical analysis in understanding market events. Over the years, various indicators have been developed to interpret volume and facilitate its analysis.

One widely used volume indicator is the On Balance Volume (OBV) indicator. It enables the comparison of price movements with volume developments over specific time periods. Divergences between price and the OBV indicator are particularly significant in this context.

Did you know?

The term "divergence" originates from the Latin word "divergere," which means "to strive apart." In technical analysis, it refers to a deviation or drifting apart between two chart developments or between price movements and an indicator's movements. In the context of volume analysis, the focus is on divergences between share price movements and the OBV.

Calculating the OBV is straightforward: If the closing price of a period is higher than the previous period's closing price, the OBV value increases by the volume of that period. Conversely, if the price decreases compared to the previous closing price, the period's volume is subtracted from the accumulated OBV up to that point. Therefore, the OBV represents a cumulative total of volume over time. This simple calculation allows for the comparison of price movements with volume developments, with the OBV changing based on the magnitude of the volume.

In general, volume should move in alignment with price action, indicating a healthy trend. The OBV trend should broadly align with the price trend. This means that when the underlying asset reaches a local high in price, the OBV should also mark a local high. Similarly, when prices are falling, a local bottom in price should correspond to a local bottom in the OBV.

Conclusion

It’s important to note that volume trading is not merely about crunching numbers or deciphering complex charts. It's about understanding the human psychology that drives market participants, the fierce battles between bulls and bears, and the collective sentiment that sways the tides of trading activity. It's about unlocking the stories hidden within the surges, spikes, and declines of volume, and using that knowledge to gain a competitive edge.

Please note: this information is not investment advice and each trader should conduct their due diligence before considering trading.

FAQs

What is volume trading?: It is a technique used by traders to analyze and interpret the trading volume of a particular asset, such as stocks, commodities, or cryptocurrencies. It involves studying the relationship between volume and price movements to gain insights into market trends, confirm trading signals, and make informed trading decisions.
Why is volume important in trading?: Volume is important in trading as it provides valuable information about the intensity and strength of market activity. High volume often indicates increased buying or selling pressure, suggesting the presence of significant market participants. Volume can confirm the validity of price movements, identify trends, and help traders identify potential entry and exit points.
How can I analyze volume in trading?: Volume analysis involves studying patterns, trends, and changes in trading volume. Traders can analyze volume by observing volume spikes or surges, comparing volume to price movements, identifying volume divergences, and using volume-based indicators. These techniques can provide insights into market dynamics and the strength of price trends.
What are volume-based indicators?: Volume-based indicators are technical tools that help analyze volume data. Some popular volume indicators include On-Balance Volume (OBV), Volume Weighted Average Price (VWAP), and Accumulation/Distribution (A/D) line. These indicators provide additional insights into buying and selling pressure, volume trends, and potential reversals.
How can volume be used to confirm trading signals?: Volume can be used to confirm trading signals by assessing the relationship between volume and price movements. For example, a bullish signal accompanied by high trading volume adds weight to the potential upward move, while a bearish signal supported by high volume reinforces the potential downward move. Volume confirmation can provide traders with more confidence in their trading decisions.
Can volume analysis be applied to all markets?: Volume analysis can be applied to various markets, including stocks, futures, commodities, and cryptocurrencies. However, it's important to note that volume data may not be readily available for all instruments, such as over-the-counter (OTC) markets. Traders should ensure they have access to reliable volume data or explore alternative indicators that reflect market activity.
What role does volume play in identifying support and resistance levels?: Volume can play a role in identifying support and resistance levels. Areas of high volume often act as support or resistance zones, where significant buying or selling activity has occurred in the past. Traders observe volume clusters at specific price levels to identify these areas, as they may influence future price movements.
How can I incorporate volume trading into my strategy?: To incorporate volume trading into your strategy, start by learning and understanding volume analysis techniques. Combine volume analysis with other technical indicators, such as moving averages or trendlines, to gain a comprehensive view of market conditions. Practice and backtest your strategy to assess its effectiveness before implementing it with real money.

Past performance does not guarantee or predict future performance. This article is offered for general information purposes only and does not constitute investment advice.