What is trading volume? Why is it one of the most important indicators?
Overview
- Volume precedes price. Observing volume can often tell us if a major price move might happen in the near future.
- Use the moving average of volume to see if trading volume is relatively high or low.
- When assessing breakouts, check to make sure it is supported by high volume.
- Volume can also be used for trending markets.
- For an uptrend, look for higher volume for each new high in price and lower volume on each pullback.
- For a downtrend, higher volume on each new low and lower volume on each counter rally.
- Volume also helps in identifying reversals. Volume usually dries up at the end of any trend, as traders lose interest and the environment for a new trend is established.
What is Volume?
As an indicator that measures how much of an asset has been traded in a given time period, volume is a very simple and powerful tool to gauge interest in that asset. While persistent volume can sustain a trend, a sharp change in volume can also indicate a reversal. “Volume precedes price” is an important saying amongst traders.
The bottom of a trading chart displays the volume with bars. For each session, the volume bar is coloured green or red depending on the closing price. The height of the bars shows the amount of volume for that trading session.
- To add the moving average for the Volume indicator on the Interdax platform, click on the screw symbol on the upper left-hand side of the trading chart.
- Tick “Show MA” on the Inputs tab and then tick “Volume MA” on the Style tab. The moving average for volume will allow you to assess when volume is relatively high or low.
Applying Volume Analysis
There are many ways you can use volume to make trading decisions. For instance, one way of using volume is to confirm the break of support levels and resistance levels, otherwise known as breakouts.
Breakouts
For a confirmed breakout, price and volume need to be moving. Suppose the price of an asset breaks through an important resistance level but the volume is very low, then it is unlikely that the market will establish itself above the resistance level for very long.
On the other hand, if there is an increase in volume as the resistance level is broken, then it sets up a high probability move for the trend to continue and a test of resistance levels higher up. But suppose you enter a trade on a high volume breakout, but then volume suddenly falls in the next few sessions and the price trades sideways, then this is a good sign to exit the trade.
In the chart above, we see that BTC-PERP ranged between $10,840 and $10,570 for a while. Volume started to increase on August 20th (as shown by the height of the bars) while the price started to move lower. The increasing volume should have alerted us to an impending downward move.
Another spike in volume followed just after 03:00 on August 21st (highlighted above) near the lows of the range around $10,570. On a break below the range, this would justify a short position as there is a decent amount of volume supporting the move.
Following the candlestick with a large sell volume, a large bearish candle was printed, and the price descended from $10,600 to $10,300.
Volume in Trending Markets
Since volume indicates the interest in trading an asset, volumes should increase progressively as a trend takes hold. However, if volume starts to falter then the trend may come to an end as interest in a certain direction fades.
If you are in a long (or short) position, then you will want to monitor volume to ensure volume is increasing in each successive high (low) and decreasing for each retracement (pullback).
The chart for BTC-USD, shown below, shows that volume increased during early May and broke through the first and second resistance, and as volume increased the price level reached a high near $8,380 shortly afterwards.
The moving average for volume increased in mid-May and sustained the rising price, which closed above the fourth resistance level at the end of the month. But then the moving average declines as volume decreases, and the price rested on the pivot point for June.
As volume picks up again, the height of the bars gradually increased as bitcoin moved from $7,600 to a high just above $13,800. Notice that the increasing height of the bars over the course of June would have indicated to remain in a long position. You could have also bought on the break of the first resistance level for June, as this was a relatively high volume day and buyers dominated the price action.
However, the large spike at the end of June correlated with the top of the price action, touching the third resistance level for June. The end of the trend was further confirmed by a large sell-off accompanied by a volume almost equivalent to that on the day the market reached a top.
Trend Reversals
If volume falters for an asset in a bullish trend, then it suggests interest is waning and a reversal is likely to follow. But a price drop during an uptrend on small volume is not a strong signal that the trend might change.
After an extended upward or downward trend, if price action is muted but volume picks up significantly and is 50 to 70 percent larger than the volume in some of the preceding sessions, then we should anticipate a reversal in the trend.
The cryptocurrency market is known for its volume spikes, where an asset appreciates or depreciates rapidly on good or bad news. You can use these volume spikes to take countertrade positions.
Suppose a coin release an announcement and volume massively increased as compared to its average volume, you can enter a short position as the volume is unlikely to be sustained. This strategy requires good timing though, as cryptocurrency announcements are the main driver of these sorts of volume spikes.