Jaroslav Kohout
Three Trading Principles For Volume Market Analysis Introduction
In this article, we will describe three trading principles for volume market analysis. Sometimes we perceive volume as binary but it is all about the relation of the volume to other variables. Essentially we will break down principles such as volume vs price, volatility, and positioning. Using these trading principles we will define possible expectations for future market moves. If you like this article about volume, you might also check out the article about the Cumulative Volume Delta indicator. Let’s get started.
This article is based on the video down below.
Three Trading Principles
Introduction
We will start with a simple yet powerful indicator – volume. Volume tells us how much transactional activity happens between buyers and sellers. Don’t forget. The sole purpose of the market is to match buyers and sellers through price discovery process. Market’s purpose is simply to facilitate trades. Our goal is to look at the volume that is being transacted and derive clues about possible future market expectations.
Volume vs Price
In the first principle, we will be looking at the relationship between volume and price. In the simplified form, we will be talking about markets where:
- price move (trend) is happening on the back of the lower volume
- price move (trend) is happening on the back of the higher volume
Let’s start with the first scenario. Down below we have a chart of Oil and we can clearly see that as the price rises, volume declines. What do we derive from this relationship? In simple terms, it means that the next significant pocket of liquidity can stop the move, and a reversal might be ahead. We can theoretically say that about any move regardless of volume, but what is an important distinguishing factor is that the speed with which we can correct previous structure created on declining volume will happen faster. This can define more clearly your objective once the reversal move has been established.
Another option is rising volume on the back of the trending move. As prices are trending, it attracts more and more participants. This is the move that should not be faded. We know that market is strongly aligned and it’s worth stepping away and don’t get run over. On the image below you can see that you can actually use the diverging price (rising price) and volume (declining volume) as a way to access the trend on the pullback (see pink arrows on the image).
Positioning
In regards to positioning a rule of thumb is simple: if we are trending but volume is decreasing, there is a lack of proper positioning being built. This positioning can be helpful when assessing higher timeframe market participants and can be crucial information for possible unwinding moves. The bigger the positioning, the stronger the unwind if the move starts to fail. Something to remember with future moves as well.
Volatility
So what is the clue about the volatility? Again it is about the relation between price range and volume. Sometimes, volatility can be high but volume average or even below average. Where is the clue? When you see the highly volatile day but average volume, it can set expectations for the next day: the next day might be likely a more balanced day, possibly an inside day. Something that can help you in selecting the right strategy for this type of day.
Trading Takeaway
Out of all the points, we would highlight as the key takeaway the price x volume relationship. You can follow these guiding principles:
- when there is a trend in a market on a higher volume, be careful fading it
- when there is a lower volume on a drifting but trending move, be cautious to go with the trend
Thanks for reading. Trade well.
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