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3 Ways to Improve a Strategy Using Real Trading Volume

3 Ways to Improve a Strategy Using Real Trading Volume

2014-11-12 03:00:00
Rob Pasche, Forex Trading Instructor
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Talking Points:

  • Using volume to confirm breakouts
  • Using volume to confirm trends
  • Using volume to identify reversals

.

For traders coming from other markets, you know the importance volume has when making trading decisions. But for years, volume has been more or less rejected by Forex traders because it has been so hard to come by. There is no central exchange for currency transactions, so there is no perfect way to measure the amount of volume actually being traded.

But with FXCM's Real Volume indicator, we can now get a sense of the amount of trading volume that is occurring on all major pairs. This is great for Forex traders, because we can now add volume analysis to our trading arsenal. In this article, we will learn 3 ways we can use volume in 3 different types of trading situations.

Volume Can Confirm Breakouts

One of the greatest fears for breakout traders is encountering a false breakout. This is when price breaks a major support or resistance level, but then crosses back to its original side. To mitigate falling for a false break, traders often wait until the current candle actually closes beyond the support or resistance level before placing a trade. This is a good technique. But another way we can confirm a breakout is by using volume.

During a breakout, it is common to see a spike in volume. An increase in volume represents a larger amount of participants that "agree" with the breakout that is occurring and can actually act as confirmation that price could continue to move in the direction of the breakout.

For an in-depth discussion on using volume to confirm breakouts, I recommend reading my previous article. But for a quick example, I have copied the chart we see below.

Learn Forex: Volume Steady During False Breaks, Spikes During Real Breaks

3 Ways to Improve a Strategy Using Real Trading Volume

(Created using Marketscope 2.0 charting package)

The 3 horizontal lines represent support and resistance levels that have been drawn based on swing highs and swing lows, and the red and green boxes represent times when price broke through those levels. However, not all of these breakouts had price follow through. Some of them were false breakouts. We can see that the two breakouts that could have resulted in great breakout trades, occurred when volume was dramatically higher than the candles around them. If we only trade breakouts when volume is elevated, this could increase our likelihood of finding better opportunities.

Volume Can Confirm Trends

Our next use for volume is valuable for traders that trade trend strategies. I already mentioned earlier how an increase of volume means there are a greater number of market participants in agreement about the price movement it coincides with. The same applies when market begins trending in a primary direction.

During a strong trend, we commonly see volume increase when price is moving in the direction of the trend, and volume decrease when price is moving counter to the trend. When this occurs, it can act as a signal to traders that the trend is more likely to continue. The greater the disparity in volume during trend and countertrend moves, the stronger the trend.

In a previous article, I go more in depth into looking for these opportunities and I've pictured one of these opportunities below.

Learn Forex: Volume Increasing with Trend, Decreasing When Countertrend

3 Ways to Improve a Strategy Using Real Trading Volume

We can see that each time price is moving up (in the direction of the trend), volume is increasing, and when price is moving down (countertrend), volume is decreasing. If we find this on our own charts, we should feel more confident placing trades that are in the direction of the trend until we see increased volume during a countertrend move (or breakout).

Volume Can Identify Reversals

The final situation when volume can be helpful is during potential reversals. Playing off the previous chart when we had a strong trend, trends will not last forever. At some point, trends will always reverse. But timing a reversal can be very difficult and very costly when we are wrong. The way that volume can be used to assist us in identifying reversals, is by looking for times when volume is decreasing at the same time that the trend is beginning to stall.

Learn Forex: Volume Decreases While Priced Tested Resistance, Then Reversed

3 Ways to Improve a Strategy Using Real Trading Volume

In the chart above, we see an uptrend in a stalling pattern where price is not able to break to a new high. During this sideways movement, volume begins to dip lower and lower which could indicate that traders are uncertain that the uptrend will continue. As soon as we see price break to a new swing low, we see volume sky rocket, confirming the reversal. For more information on using volume to identify reversals, click here.

Good trading!

---Written by Rob Pasche

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