How to Day Trade Using Price Action: Volume analysis – Ep. 7

Today, let’s talk about volume. I have mentioned volume and the importance of analyzing volume a few times so far in this series, so today I want to focus on volume.

So first of all, what is Volume ? Well, volume is the number of shares or number of contracts that are traded during a time period like a candle. In forex you don’t have volume, you don’t have the information about how much was traded at any given time, but most other tradable instrument will have the volume, like stocks, futures or commodities. In forex you have tick volume, showing you how many ticks took place during that time – it is different.

Anyway, if you think about stocks for example. Every time somebody buys and somebody sells any number of shares, the number of shares are added up. So in stock trading you have deals taking place all the time, somebody buys 1 share of apple, another one buys 1000 shares of Tesla, Warren Buffet buys Coca-Cola for a billion dollars! All those shares are added together and what you get at the end of the day – that’s the volume for that day. The number of shares that changed hands.

Of course you can, and as a day trader you should, also split the daily volume into hourly volume – or volume for 1 minute, or 5 minutes or 15 minutes, so volume is very useful for day traders as well.

When you look at a chart that displays volume, you will usually see the volume at the bottom of the chart, like bars sticking up. It is either called bar graph or a histogram. I have no idea which, but it’s one or the other. During my time at the university, some of the classes were more boring than others. Statistics in particular was something that I slept through most of the time, so I got bar graphs and histograms mixed up and the professor probably thought I was pretty stupid. So guys do yourselves a favor and pay attention to what your statistician tells you.

OK enough of the side track — the volume is displayed as a bar graph. In layman’s terms that means these bars sticking up from the bottom of the chart.

Together with the candles the volume will give you a lot of information. By analyzing trends and changes in the character of the volume, together with analyzing the movements in price you can get a better understanding about the relationship between supply and demand.

As you learned in a previous episode – the one with the silly cat – it is the relationship between supply and demand that determine if the prices are going up or if the prices are going down.

All good economists will tell you that:

If demand overcomes supply, then prices will increase.

and

If supply overcomes demand, then prices will decrease.

If there is huge demand for something, then the seller can increase the price and people will still want to buy. Or there can be limited demand, but if there is not a lot of supply the prices will still be high. So for example scarcity can lead to high prices – when I was looking to buy a vintage german sports car. There are not a lot of those lying around, so you cannot just go to any used car salesman and ask for a classic Porsche. Even if you found one, it might not be in that good condition. So at any given time there are not that many vintage Porsches in top condition. So there is limited supply – there is also limited demand – but prices are still high. There are not that many buyers either, so the prices are not extreme, but they’re still elevated.

So each volume bar at the bottom corresponds to a candle in the candlestick chart. When you have many candles in a chart, you also have many volume bars.

To explain the simplest way to analyse the volume, I sometimes use the car fuel analogy. You see you can consider the volume bars to show you how much fuel that the car consumes, and the price itself is the vehicle that is moving. You would expect the fuel consumption to increase when the car goes fast, and when the car slows down you would expect the fuel consumption to decrease. When you have big candles, up or down, you would expect big volume. When you have small narrow candles, the volume should be less.

There are two main ways you can gauge the volume on up waves. Either the volume increases on the upwaves, or it decreases. If the volume increases on the up move, then you can be fairly sure that there is good demand. When you have a series of up moves or up waves, if the volume increases on the upmoves, compared to the pullbacks, then you can be fairly sure that the series of upmoves will continue. The pullback will have lower volume in a healthy up trend, there is not as much selling as there is buying, so when buyers enter the market on the up moves – the volume should increase if you have a healthy up trend..

But if the volume diminishes on the upmove, there is no more demand. The market is running out of steam, and could well turn into a down trend soon.

Sometimes there is a period of Equilibrium before the market moves from a up trend to a down trend. During that period of equilibrium the market is in a horizontal channel. If the volume is picking up on the downmoves and decreases on the upmmoves, then chances are the market will start a new downtrend soon.

Same thing in a downtrend when you have price waves moving lower and lower. If the volume picks up on the down moves, and decreases on the rallies, then it is likely that the down trend will continue. If the volume starts to dry up on the down moves, then after a period of equilibrium, the market will form an up trend

That was the very basics of volume analysis – a bite size. In the next few videos in this series we’ll delve further into volume analysis, and then also start combining the volume with the analysis of the candles and get a good understanding about how you can use this information in your price action trading.

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