I’ll be the first to admit that there is MUCH room for growth in my own development as a trader… in terms of knowledge, skill and attitude. In fact, I recognise that it’ll be a life-long journey.

One area that has a lot of scope for development is my use of volume analysis.

If you’ve been on my site for a while you’ll note that I usually have volume displayed on the lower portion of my charts. In fact, it’s on every chart on my workstation, except for the 1-range. And this naturally leads to a couple of emails a month asking how I use it. It’s been a difficult question to answer, as volume has NEVER been a major part of my analysis background.

With much of my trader development occurring in the spot forex market, there was no reliable volume information. However upon moving to futures approximately two years ago reliable volume figures were available, so I added it to the chart and did some introductory reading with the expectation that I would intuitively develop some pattern recognition skills over time.

So… where am I at now? Volume is still a very minor part of my analysis. I trade price action. Or more correctly… I trade other trader’s perception of price action (YTC PAT). However volume does offer value as an analysis support tool.

So, having been asked again this week I thought I should closely follow my thought processes as I analyse a trading session, to observe when volume plays a significant part, and to once and for all document how I use volume as an analysis support tool. Of course… we can expand on this in future as I develop more insight into volume analysis.

Please note… this is just the way I use it. For a more in-depth exploration of the topic, I would recommend researching the fields of Wyckoff Analysis and Volume Spread Analysis (VSA).

The primary signal I am looking for is a large and sudden increase in volume. When there isn’t such a signal, I typically place very little emphasis on volume due to too many conflicting or ambiguous signals. A sudden increase in volume attracts my attention. Anything else… I don’t care what it’s doing.

Large and sudden increases in volume indicate areas of price action which have attracted a lot of attention from other traders. Price will move from here, proving some of these traders as winners and some as losers. This creates an area of emotion on the chart, which will potentially impact upon future decision making.

Here’s a quick summary of how I use this sudden increase in volume…

  • A large increase in volume which initiates a bullish price move, will identify an area of potential support should price return to this area. (initiating volume)
  • A large increase in volume which initiates a bearish price move, will identify an area of potential resistance should price return to this area. (initiating volume)
  • A large increase in volume which stops a bullish price move, will identify an area of potential resistance should price return to this area (stopping volume)
  • A large increase in volume which stops a bearish price move, will identify an area of potential support should price return to this area (stopping volume)

Finding these occurrences of initiating or stopping volume is simply a case of scanning the volume below the price chart. I overlay my volume with an EMA(9). A sudden spike from average volume levels to around twice the average… gets my attention.

You should recognise these scenarios most often at key price action areas. For example, initiating volume on a successful breakout, as breakout traders pile in to the market and those trying to fade the move scramble to get out. And stopping volume at the end of a climactic move.

You’ll note that all four rules relate to the potential for the area to provide support or resistance, at some time in the future should price ever return there. For the more experienced trader, you may also be able to take advantage of stopping volume right now, through joining the orderflow which helps stop the price move, or joining it as the failure to continue is confirmed. You’ll recognise these occurrences at a test or breakout failure of a support or resistance level. I rarely join initiating volume right now… as that would entail chasing price… usually a big NO in my book.

Let’s look at some examples from yesterday’s Euro chart, 13th April 2011.

 

(more…)