Trading with Volume

Volume is one of the strongest indicators for market action. Using it can not only empower your trade entries but also warn you of weakening trends. In this article you will learn to incorporate Volume in your trading.


Volume precedes Price
We will now describe several truths regarding indicators, price and predictive abilities. Indicators are a derivative of price, meaning that they are calculated from information extracted from price, therefore they will always be somewhat lagging behind price and their predictive abilities will decrease.

Volume, unlike indicators, is not calculated from price, quite the opposite - price is the result of action of buyers and sellers which is presented as the Volume. This is the reason why Volume is a very strong technical tool and is very useful in predicting and trading the FOREX markets.

Volume should Confirm Price Action
Because of Volume's strong connection with price, it can be used as a leading indicator with regard to price action. The main principle for incorporating volume in your trading is that Volume should Confirm Price Action.

Example:
If price is in an uptrend, Volume should also be in uptrend. This signals that the uptrend is healthy and has 'fuel' for advancing.
If price is in a downtrend, Volume is also important though a bit less. A downtrend can take place even without a strong volume.
If price is in a range, Volume should be average and not too strong.

When volume does not confirm price movement - e.g. Price is moving up while Volume is moving down. Each divergence of Volume and Price can indicate that the trend is about to reverse. Note that this is merely an indication and not a trading signal. More confirmation and signals of other indicators should be used to confirm and take trades based on this analysis.


Indicators that Use Volume
In order to have a more objective means of analyzing Volume action, one can use several indicators that incorporate Volume in their calculation. This includes the Money Flow Index and Force Index.

The easiest method of trading with Volume is to place a Exponential Moving Average to smooth it. While the readings of actual, raw volume are hard to interpret, the smoothed values are easier to trade by and reach trading conclusions.