The Benefits of Volume Analysis

05/16/2013 6:00 am EST

Focus: FOREX

Marc Principato

Director, SMB Forex training Program

Volume analysis can help you time your positions with more precision than conventional chart analysis alone, says Marc Principato of SMB University Forex Training Program.

Whenever I mention "volume analysis" in relation to forex trading, almost instantly I get the following question: "Hey, isn't the volume in the spot market unreliable since there is no central exchange?" The answer is yes, it is unreliable, and that is why when I analyze volume in the currency market, I don't use spot, I use futures. The next question is usually something like, "Are you using time and sales? Or comparing the volume bars on the chart?" This is a great example of the types of preconceived notions that exist in this business. The volume that I analyze is similar to time and sales, but presented in a way that allows for greater market insight.

Many less experienced traders have a very conventional view of the world and do not realize it is the uniqueness of your perspective that allows you to navigate markets effectively. When discussing the subject of volume, people usually think of the traditional time and sales, and volume bars on the lower region of a chart. People are usually not exposed to the concept that the buying and selling activity within each period unfolds in unique and repetitive patterns. In order to see these patterns, traders need to have an unconventional view of the market. Your typical charting package, especially in the forex space, doesn't even come close to what is required to do effective volume analysis.

The kind of volume analysis that I am referring to has to do with what are called "market deltas." The market delta is a number that represents the difference between all the contracts that were executed on the bid vs. executed on the offer over a range of prices during a particular period of time. Alone, market deltas are of no particular value, but when examined over a series of periods, some interesting patterns emerge. For example, one of the first signs we look for to confirm a market reversal is a 200% net change between two periods. So this means if we are looking for a bullish reversal and we observe that the period containing the low of the day has a net delta of -1200 (that means once this period closed, there were 1200 more contracts that were sold) followed by the close of the current period, which shows a net delta of +1500, we have over a 200% change between the two periods.

This is a very important pattern that will help our traders determine how to position themselves for the emerging bullish reversal. What is happening here is that is a clear change in who is in control during these periods. Sellers have been absorbed and buyers are present. Is this information alone enough to enter a trade on? No, but it is a very important first step to putting an intraday trading idea together.

The lesson to take away here is this: Volume analysis is an effective tool for validation when you are using a sound methodology for your market judgments. It can help you time your positions with much more precision than conventional chart analysis alone. It is all about recognizing these unique patterns when your methodology is pointing to an emerging trade opportunity.

By Marc Principato, CMT, Director, SMB University Forex Training Program

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