Volume is a measure of quantity.
In trading, the volume is the amount of a particular asset traded over a period of time.
It is the number of units, shares, or contracts that change hands between a buyer and a seller.
The more actively traded an asset is, the higher the volume will be (and vice versa).
Volume is a key indicator of market activity and liquidity, which means that it is often presented alongside price information.
Whenever a contract is traded, there has to be a buyer and a seller in order for the transaction to take place.
Each transaction is a single exchange and will contribute to the trading volume.
It is worth noting that the number of actual transactions is not given in the trading volume, it is the number of assets traded that is counted.
So, if 100 buyers purchase one share each it looks the same as if one buyer purchases 100 shares.
When a market is described as “active” it indicates that the trading volume will be higher, and if the market is described as “inactive” it means that the trading volume will be lower.
The trading volume is usually higher when there is a significant price fluctuation in the market.
Volume can be used to measure stocks, bonds, options, futures, commodities, and forex.
However, volume is used most often in stock trading, where it shows the number of shares that are being traded.
As volume offers an extra dimension when examining an asset’s price action, it is a popular tool in the technical analysis of financial markets.
It helps determine the strength of price movements.
If a price movement is accompanied by a proportionate increase in volume, it is seen as more significant than one that isn’t.
Each market or exchange will track its own volume and distribute the data to traders. These volume reports usually come out in real-time, but they are only estimates.
For accurate volume figures, traders usually have to wait until the end of the day.
However, there are other ways that traders can determine market volume, such as the tick volume or number of price changes.
If the market price is changing rapidly, it can be an indicator of high trading volume.
The Importance of Volume in Technical Analysis
Volume is an important aspect of technical analysis because it is used to confirm trends and chart patterns.
Whenever the price of an asset increases or decreases with relatively high volume, it is viewed as a stronger, more significant move.
If the price fluctuates in a similar manner but the volume is relatively low, then the move is viewed as weak.
This is why it’s important to analyze both the price movement as well as the volume in order to gauge the validity of trend reversals, trend continuations, and chart patterns.
Technical analysis of an asset’s volume helps traders determine if certain situations are occurring, such as a true trend reversal.
For example, if bitcoin jumps 20% in one trading day after being in a long downtrend. If the volume is high during the day relative to the average daily volume, it is a sign that it is reversing its trend.
On the other hand, if the volume is below average, there may not be enough indication to support a true trend reversal.
Volume precedes price.
An important belief in technical analysis is that an asset’s price is preceded by its volume.
Volume is closely monitored by traders to form predictions of upcoming trend reversals.
An example of this belief is when volume is starting to decrease in an uptrend, it is usually recognized as a sign that the upward price movement is about to end.
Volume should confirm the trend.
If the price is moving in an upward trend, volume should increase. If the price is moving in a downward trend, the volume should also increase
If the previous relationship between volume and price movements starts to deteriorate, it is usually a sign of weakness in the trend.
For example, if the price is in an uptrend but the up trading days are marked with lower volume, it is a sign that the trend is starting to lose its legs and may soon end.
Volume should confirm chart patterns.
Patterns such as Head and Shoulders, Triangles, Flags, and other chart patterns should be confirmed by volume.
For example, during an upside breakout in an Ascending Triangle, it should be confirmed with an increased amount of volume.
If the volume is not there to confirm the breakout move, the quality of the signal formed by the chart pattern is weakened.
The Challenge of Using Volume in Forex
The forex market is the largest and most liquid financial market in the world, with daily trading volumes reaching trillions of dollars.
While the high volume of trading is awesome, there are also some challenges that traders face when trading the forex market:
- Fragmentation: The forex market is highly decentralized and fragmented, with trading taking place through a network of banks, financial institutions, and electronic platforms rather than a centralized exchange. This fragmentation can lead to disparities in pricing and liquidity between different trading venues, making it more challenging for traders to identify the best prices and execute trades efficiently.
- Lack of transparency: Due to its over-the-counter (OTC) nature, the forex market lacks a centralized source of trading data and pricing information. This can make it difficult for traders to access comprehensive and accurate information about market depth, trading volumes, and historical prices, which may hinder their ability to make informed trading decisions.
For a better understanding of how the forex market is structured, read our lesson, “Where Are Retail Forex Traders Actually Trading?“.