TA Crash Course: Volume

Volume is an important technical indicator that should be used on every price chart. The volume indicator represents the total trading activity for a specified time period, meaning how many actual units of an instrument have been exchanged.

This information is usually represented by vertical columns at the bottom of the chart. Higher volume bars mean trading activity was heavier for the particular time period, while smaller columns indicate less trading activity.

Volume is a real time indicator that can also be thought of as the level of interest traders have in an particular instrument at a particular price point. For example, it’s not uncommon to see volume surges after a significant news event or at price points of support and resistance.

Like with all technical indicators, there are several different ways to use volume in a trading strategy and most technical traders use the volume in combination with other techniques. In general however, volume is used to confirm price action.

How to setup volume

The volume indicator is extremely simple to set up as it only has a few options. The source of volume is specific to the exchange represented in the chart. Each column represents the total volume for the corresponding candle or bar.

Technical Analysis Tutorial: Volume Indicator Basics Explained
Volume Indicator Basics. Click to Enlarge.

On the one hour chart, a single volume bar would represent the total trading volume for that hour. On the daily chart, a single volume bar would represent the total units traded for that day.

Volume indicators may also come equipped with a moving average that can be plotted with a specific time period. For example, a MA value of 20 would produce a moving average based on the previous 20 volume bars.

The colors on the Volume indicator have meaning as well. A green volume bar means that the instrument closed higher on that candle than the previous candle close. A red volume bar means that the instrument closed lower on that candle compared to the previous candle close.

Volume Represents Market Pressure

The volume level measures the intensity behind a price move. Heavier volume indicates a higher degree of pressure in the direction of the trend.

By monitoring the level of volume along with the price action, it’s easier to gauge buying or selling pressure behind market moves. You can use this information to confirm price movement or warn that a price move should not be trusted.

As a general rule of thumb, volume should increase or expand in the direction of the existing price trend.

  • In an uptrend, volume should increase as price moves higher and should decrease on price dips. When this happens, volume is said to be confirming the price action.
  • In a downtrend, the volume should increase during down moves and decrease on bounces. As long as that pattern continues, it means the selling pressure is greater than the buying pressure and the downtrend should continue.

When this price/volume pattern begins to change it’s time to start looking for signs of a reversal.

How to confirm price action using the volume indicator.
How to confirm price action using the volume indicator. Click to enlarge.

By monitoring price and volume together, you are actually using two different tools to measure the same thing – market pressure. Because price is trending higher, you can see that there is more buying pressure than selling pressure. It is for the same reason that the greater volume should take place in the same direction as the prevailing trend.

Technical analysts believe that volume precedes price, meaning that the loss of upside pressure in an uptrend or downside pressure in a downtrend will show in the volume figures before a reversal of the price trend.

 Confirming Price Movements

Volume divergence occurs when price makes a higher high on declining volume, an indication of diminishing buying pressure. If the volume rises on price dips, it’s possible that the uptrend could be coming to an end.

Volume divergence occurs when price makes a higher high and volume makes a lower low.
Volume divergence example. Click to enlarge.

Volume should also reflect price action in chart patterns. For example, a break of a triangle continuation pattern should be accompanied by heavy volume to confirm that breakout is real. This rule can also be applied when breaking a trendline.

Volume should reflect price action in chart patterns.
Confirming price movements using volume. Click to enlarge.

Summary

  • Volume is a real time indicator that can also be thought of as the level of interest traders have in an particular instrument at a particular price point.
  • Each column represents the total volume for the corresponding candle or bar.
  • Colors represent whether an instrument opened or closed relative to the previous candle.
  • As a general rule of thumb, volume should increase or expand in the direction of the existing price trend.
  • When this price/volume pattern begins to change it’s time to start looking for signs of a reversal.
  • Volume should reflect price action in chart patterns. Divergence and increased volume on break outs are just a couple of examples how volume can be used to confirm price movement.

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