Hello Forex Traders!
Have you ever traded futures and/or stocks?
Irrelevant of the answer, everyone knows how important volume is for the analysis of stocks and futures. Volume, open interest and price action are the key components in trading decisions.
Did you notice that volume does not have the same importance as in stocks and futures? Or, in fact, did you ever use volume on your Forex chart? How is volume measured in the Forex market? Does the Forex market use volume levels as well? We are going to discuss all of these questions, and more. Please write down your own experiences in the comment section down below.
By the way, don’t forget to read last week’s article on the “Path to Forex Trading Mastery”. It is well worth your time as you will be able to identify how advanced your trading is and how you can move on to the next level!
The Forex market is a decentralized market, which means that there is no method of keeping track of the number of contract and contract sizes, such as in the stock market. The Forex market measures volume by counting the tick movements. The logic behind this is straight forward:
a) Price moves up and down in ticks
b) The Forex market cannot measure how many contracts are sold, but it can measure how many ticks price moves up or down in any given time frame
c) Volume can still be measured by measuring how many ticks price moves up and down
d) Therefore, irrespective of how many transactions have been completed to make price move, the net effect will be measured
It is the equivalent of focusing on the next result instead of analyzing the process. The volume measurement in the Forex market is looking at how much price moves within a certain period and it does not care how many or few buying and selling transactions are in fact needed to make that price move 1 tick. All it knows is how many ticks it moved, regardless of the fact if 100 trades were involved or 10,000.
HOW TO USE VOLUME
Price action is always our primary focus and we should never forget that!! Write it down on a piece of paper, if need be, with a thick yellow mark: price is the number 1 measurement! Almost everything is derived from price and calculated based on price, so using price action as the primary source for decisions is only logical.
Using volume for trading decisions makes sense if it is used as a confirmation. Here are its primary advantages:
1) CONFIRM TREND STRENGTH: Volume can confirm the trend direction as traders want to see increased volume in the direction of the trend and decreased levels of volume when the currency pair is correcting in the opposite direction of the trend.
- For an uptrend this means: increased volume when price is moving up and decreased volume when price is moving down.
- For a downtrend this means: increased volume when price is moving down and decreased volume when price is moving up.
2) IDENTIFY TREND WEAKNESS: If price is reaching new levels of extremes (higher highs or lower lows), but volume is not confirming and supporting those new price levels, then this could provide first warning signals that the trend is weakening (retracement can be expected) or ending (reversal potential, or sideways / range movement). Read here more information how to interpret divergence.
3) BREAKOUT CONFIRMATION: During a consolidation, volume measurements typically are low. If volume picks up upon the break of that consolidation pattern (wedge, triangle, flag, etc), then volume is confirming a higher chance of a sustainable break out. Read more on trading break outs here.
In previous articles of mine we have discussed how to interpret the above mentioned elements. Please go to these links for detailed and in-depth information:
Accumulation is a phase when buyers are controlling the market. If the volume is increasing when the market is correcting in a downtrend, then this typically means that more buyers are stepping into the market and a reversal could occur. Usually these are confirmed when:
a) Volume increases compared to the day before but closing prices are higher
b) Price hardly moves down, even though volume has increased
Distribution is a phase when sellers are controlling the market. If the volume is increasing when the market is correcting in an uptrend, then this typically means that more sellers are stepping into the market and a reversal could occur. Usually these are confirmed when:
a) Volume increases compared to the day before but closing prices are lower
b) Price hardly moves up, even though volume has increased
There is an indicator that measures this accumulation/distribution balance and is called Accumulation/Distribution (AD). It is calculated as follows:
AD = ((Close – Open) / (High – Low)) * Volume
If the indicator is falling then it indicates distribution (selling) of the currency. If the indicator is rising then it indicates accumulation (buying) of the currency.
METHODS TO CALCULATE VOLUME
Here is a list of tools a Forex trader can choose from.
The most logically place to start is with the volume indicator. This tool calculates the number of ticks which a currency moves up and down. It is often used in other calculations as well. For instance, the AD methodology mentioned in the paragraph above includes volume as part of its basic parameters.
ON BALANCE VOLUME (OBV):
The tool was developed by Joe Granville and is used to detect whether volume is bearish or bullish oriented. OBV marks the particular volume of the day as a bearish or bullish depending whether the day has been bearish and bullish. It then adds/detracts that volume to the running open total. The total then indicates the overall sentiment of the market.
MONEY FLOW INDEX:
The money flow index shows the money flow and is calculated in a few steps. I recommend going to this link to read the steps yourself.
MARKET FACILIATION INDEX (MFI):
The MFI is created by trader Bill Williams and is based on volume as well. The MFI is calculated by:
MFI = (high – low) / volume
The formula is very simple, yet provides various interpretations in combination with volume. There are 4 different combinations based on MFI and volume. The color codes have the following meaning:
COLOR MFI / VOLUME MEANING B.WILLIAMS DESCRIPTION
1) Green MFI UP / VOLUME UP TREND CONT GREEN
2) Brown MFI DOWN / VOLUME DOWN TREND END FADE
3) Blue MFI UP / VOLUME DOWN SPIKES FAKE
4) Pink MFI DOWN / VOLUME UP START SQUAT
Green indicates a strong trend continuation mode. Brown indicates a potential area of the trend ending. Blue occurs in environments when a market spikes into 1 direction, often causing confusion about the trend direction. Pink indicates the beginning of a trend continuation or reversal.
These are the volume tools you can use in the Forex market.
Remember, price is always our number one guidance for analysis and trade decisiosn. Our technical analysis is focused on price. Volume is only a confirmation or warning signal, nothing else. Please let us know your opinion down below!
Thanks for reading and for sharing the article!
Have a great weekend and Good Trading!
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