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PTMC team 27.10 2015

Volume as an indicator of the dominant force on the market. Part 1

Hey there, Protraders!

Most traders, who use the methods of the classical technical analysis, focus their attention only on the price, indicators and different timeframes, ignoring other important data, such as volume or open interest. Certainly, such approach is successfully applied in practice, but, unfortunately, it limits the trader’s understanding about the current market state, and which dominant force prevails on the market. The volume, for the professional market participants, it is an integral part of their trading strategies, since it takes into account the mood and opinion of all market participants. With the development of electronic trading market, the information about traded volume has become available not only to the large market participants, but also to the ordinary trader.

trading volume in Protrader

Before talking about the trading methods using volumes, let’s consider the basic concepts. Volume – is the number of contracts, which were bought or sold by a specific price for a certain period of time (hour, day, week, month). Simply put, the volume shows activity of the trading for a certain period. If to consider the data by the volume separately, they will not say much. It is necessary to analyze the volume in the common market context, i.e. to compare relatively to a certain period of time. Therefore, if to compare today’s volume with the volume over the previous N days (or bars), then it can be easily seen what size the volume has, high or low. In addition, it is necessary to check data by the volume with price, look near which levels the positions were accumulated, for the subsequent creation of pulsed movement.

Types of the volume

In turn, the volume can be divided into several types:

Volume types

  • Tick volume – is the number of contracts, which were traded for a unit of the price change. I.e. roughly speaking, this is the volume that could move the price on 1 tick.
  • Quantitative volume – displays the number of trades made over a certain period of time.
  • Exchange volume – displays the number of traded contracts for a certain period of time by a specific price, creating a price level from which the pulsed movement could begin. Usually, such volume is represented as a horizontal profile for a certain time range.

Basics of the volume spread analysis method

The most common displaying of the volume is a vertical histogram as shown on the example below:

histogram volume in Protrader

The whole volumetric analysis originates from Wyckoff's method, named for the founder – Richard Wyckoff, who was able to describe very accurately the process of accumulation and distribution of the asset price. Hereafter, this method has undergone a number of changes and additions, so now the most popular is considered the VSA (Volume Spread Analysis) method, which is based on the joint analysis of several parameters:

  • volatility of the price series – in understanding of VSA, this is the difference between the high and low of the bar;
  • the number of the traded volume;
  • the close price of the bar – this parameter is one of the most important in the methodic of VSA.

Why does the VSA work? When major market participants are trying to reach their financial goals, they increase their trading activity, thereby increasing the volume of the trading. Conversely, when major participants already have open positions, and do not make a significant number of trades, then on the chart it is reflected in the form of a small volume. Certainly, this is not an axiom, since a large volume can be accumulated by smaller market participants.

 Volume spread analysis in Protrader

Common essence of the VSA method reduces to the analysis of interconnection between the magnitude of the volumes and size of the bars, or in economic terms the definition of supply and demand. In the first place, each bar must be analyzed separately, after that combined into an overall picture, and then based on a complete picture, an assumption about the future price movement can be made.

There are several characteristics, which must be used when analyzing the volume. Primarily, this is a spread, i.e. the difference between the maximum and the minimum of the bar. Spread of the bar – is one of the most important characteristics and it has a qualitative dimension.

Spread is divided into several categories – narrow, medium and wide. Thus, spread of the bar is compared with the previous 20-30 bars.

Another important parameter – is a location of the price closure relatively to the entire bar range, which is located in the top, medium or bottom part of the bar. Herewith, apart from the close price location of the current bar, traders are still looking at the closure of the previous bar. If the current closure is higher than previous closure, then it is an up bar, and if the current closure is lower than the previous one, it is a down bar.

The volumesare also compared relatively to each other and their sizes are visually estimated and divided into low, medium, high and very high.

main characteristics of VSA

Main VSA patterns

Based on the candle sizes and the volumes, traders have designed various patterns, which can consist of individual bars, as well as of their combinations. It is worth mentioning an important feature that in contrast to a simple technical analysis in the VSA method there are no reversal figures or continuation of the trend. Models are classified differently in this theory. All patterns are divided into so-called patterns of "strength" and "weakness". But, before proceeding to the description of the patterns, it is necessary to understand what volume is considered to be the most important on the chart. Certainly, this is an extremely high volume, since it often points on the top or bottom of the market, and gives us an advance information on upcoming reversal.

The most popular pattern is considered to be the "Up-trust", which has a similar structure to one of the Price action patterns – Pin bar. The peculiarity of this pattern is that it always occurs on a very large volume, has a wide spread and closing in the bottom of the bar. The main condition for the formation of this pattern is to update the local maximum, i.e. such a bar should always be on top of the wave. Update of the maximum with further closing of the bar in the bottom third shows that customers do not have enough resources to continue the upward movement after breaking the previous high.

The "Pseudo Up-trust" pattern is often met, which must also update the local maximum, has a wide spread, and herewith is formed at a low volume. Pseudo Up-trust appears in the case, when the large players do not actively participate in the market, and allow small participants to create a correctional movement.

Pattern "Stopping volume" as well as the previous patterns can be easily found on the chart, since it often appears on the strong levels of support and resistance. The main differences are as follows: medium or wide spread, the bar must update the local maximum, should have closing in the middle or bottom of the bar. The obligatory condition is – a very high volume (over the last 20 – 30 bars). The occurrence of this pattern does not guarantee that the price will unfold. This only specifies that there was the opposite force, which starts absorbing the demand andthe reversal may start soon.

VSA pattern "Stopping Volume"

All listed above patterns are formed on the ascending trend and, therefore, they indicate on estimated completion of the trend. Thus, for the descending trends, these patterns will be identical except that they should update the local minimum and have the close price at the top of the bar.

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