Trading Volume as a Market Indicator
November 11, 2021
Stock price movements aren't always what they appear. Beneath the surface of a
move higher or lower, trends may be forming—or fizzling into a reversal. That's why
traders look for other indications of enthusiasm when they want to confirm or refute a
price signal. Trading volume, which measures the number of shares traded during a
particular time period, can help.
While swings in trading volume may not be enough on their own to reveal changes in
a trend, they can give you a sense of how much strength there is behind a move.
Here's how you can use volume indicators in your trading.
What traders look for: In short, above average and/or increasing trading
volume can signal that traders are truly committed to a price move, which you can
see in Chart 1 below, where the price and volume lines are both increasing.
Contrariwise, below average and/or decreasing volume can signal a lack of
enthusiasm, which you can see in Chart 2, where volume is declining even as the
price continues to creep higher.
Source: Charles Schwab & Co.
Bullish signals from trading volume
Here are some common ways to use volume to confirm a bullish price move, as well
as an example of how volume can undermine a price trend.
Upside breakout with above average volume
During uptrends and in sideways markets, a stock's price will occasionally run into a
resistance level—a point where upward trends start to fizzle as selling pressure
overcomes buying pressure. When a stock's price breaks through that level, the
breakout is generally believed to be more significant if volume is high or above
average. A breakout accompanied by low volume suggests enthusiasm for the move
may be lacking.
Source: Charles Schwab & Co.
Uptrend accompanied by increasing volume
An uptrend paired with increasing and/or above average volume implies investor
enthusiasm for that stock or asset is strong, which could lead to more buying and
even higher prices.
An uptrend with decreasing volume An uptrend without increasing and/or
above average volume suggests investor enthusiasm is limited. While the price could
continue to rise, many traders who use volume analysis will nevertheless look for
other candidates.
Source: Charles Schwab & Co.
Bearish signals from trading volume
Here are some common ways to use volume to confirm a bearish price move, as
well as an example of how volume can undermine a price trend.
Downside breakout accompanied by heavy volume
During downtrends and in sideways markets, a stock's price will occasionally run into
a support level, which is where downward trends tend to weaken as buying pressure
overcomes selling pressure. When the price breaks below a support level, the
breakdown is generally believed to be more significant if volume is high or above
average. A breakout accompanied by low volume suggests enthusiasm is lacking.
Source: Charles Schwab & Co.
Downtrend accompanied by increasing volume A downtrend accompanied
by increasing and/or above average volume implies investors have doubts about the
stock, which could lead to more selling and even lower prices.
A downtrend with decreasing volume A downtrend without increasing and/or
above average volume implies investor concern is limited. While the stock's price
may continue to fall, traders who use volume analysis may start to follow the stock
and watch for signs of a pickup supported by increasing volume.
As a rule of thumb, any price breakout or trend that is accompanied by above
average volume could be considered more significant than price movements that are
not.
Forexbee.com
The Volume Underlay indicator, aka Volume indicator, plots volume bars on the chart to illustrate the
buying and selling activity over a specific period.
The bars of the indicator comes in red and green colors. Green bars mention the buying volume,
while red bars mark the selling volume.
The Volume Underlay indicator isn’t used alone; you need to combine it with the price action for
entering and exiting trades.
Volume Underlay indicator
Reading the Volume Underlay indicator isn’t difficult. The red and green bars make it easier to
analyze buying and selling pressure. If the indicator makes green bars, it suggests the closing price is
higher than the previous close and there is a buying volume.
Conversely, if the indicator makes red bars, the closing price is lower than the previous close,
indicating selling pressure.
When reading the Volume Underlay indicator, you’ll often see volume spikes. It indicates there is a
lot of buying/selling pressure compared to the previous sessions.
Usually, the Volume Underlay indicator spikes when there is a lot of market volatility, like a news
event or the smart money (financial institutions, central banks, and other big players) are placing
their trades.
You don’t want to be on the other side of smart money, as you can get stopped out quickly. So, by
identifying smart money behavior through the Volume Underlay, you can enter the trades along with
them and exit when there is a low volume.
In addition, you can find if there is liquidity. Volume and liquidity are directly related to each other. A
high volume means there is high liquidity, and you can quickly enter and exit the trades instead of
staying in consolidation.
The good thing about the Volume Underlay indicator is it works on all timeframes. Therefore it is
suitable for all types of strategies.
Trading the Volume Underlay Indicator
You can find market trends and price strength with the help of the Volume Underlay indicator.
However, you need to combine it with the price to use the indicator in your strategies.
Volume plays a key role in identifying the ongoing trend. If the price and the volume is rising
(appearance of green bars), it suggests an uptrend. Conversely, if the price and volume are falling
(emergence of red bars), it mentions a downtrend.
In the chart above, you can see after the appearance of red and green bars; there was a trend
continuation.
You can also use the Volume Underlay indicator for detecting price reversals.
If the price is moving in an uptrend, but the volume is decreasing, it suggests a possible downtrend in
the future. On the other hand, if the price is moving in a downtrend and the volume is decreasing,
it’s a sign of a potential reversal.
Volume Underlay indicator can also act as a confirmation when trading with other indicators. If the
indicator is showing a trend, but the volume is decreasing, it’s better not to take positions, as it is a
sign of possible reversal.
In the chart below, you can see when the MACD pointed to an uptrend, there was an increase in
volume, thereby confirming an uptrend.
Another way to trade with the Volume Underlay is through a range breakout. After the initial volume
spikes, there is a continuation of a trend, and the indicator plots volume bars in a range. However,
when the volume bar breaks through this range, it suggests a reversal.
In the chart below, we got an initial volume spike, and the price went downwards. The volume stayed
in a range afterward, but once the green bar broke through the range, there was an uptrend.
Advantages
The indicator is super easy to use.
You can combine it into multiple strategies.
It can tell you the behavior of smart money.
Limitations
The Volume Underlay doesn’t work best on its own.
The red and green bars don’t necessarily mean a bullish or bearish momentum.
Summary
The Volume Underlay indicator helps in determining the trend’s continuation and reversal. Also, it
can help you navigate the behavior of financial institutions, so you can trade along with them rather
than trade against them.
You need to combine the Volume Underlay and the price to understand the market trend better.
