Volume trading explained

What is volume trading?

Volume trading is when traders use volume – the amount a particular asset is traded over time – to look at the significance of certain moves within the markets.

Volume plays an important role in trading for many, but is an element that is typically overlooked by retail traders for a number of reasons.

Why is trading volume analysis overlooked?

One of the most difficult elements for traders seeking to utilise volume as part of their trading strategy is the question over whether the data being provided by their broker is reliable. Many of the brokers who provide volume data will be supplying the volume of trades placed by their clients. This is in stark contrast to the total market volume, which would play a much more significant role in understanding where the market will go next. The problem often lies in the fact that such data costs money, and certain markets are easier to obtain data for than others.

Consider the forex market, a trillion dollar a day exchange that involves transactions across a host of platforms. The decentralised nature of the FX market makes it more difficult to quantify. It is also worthwhile noting that volume will often reflect peaks and troughs in trading activity according to the time of the day. For instance, the FTSE 100 will traditionally see a sharp rise in volumes at both the open (crossover with Asia) and close (crossover with the US) of the market.

How to use volume in your trading

Volumes are typically seen as a confirmation tool. If we see an upward surge in price, the question over whether it is accompanied by a big uptick in volumes will provide significant information over whether that price rise is something worth paying attention to.

Look for sharp market moves backed by volume rises

As a general rule, a sharp market move that is accompanied by a significant rise in volumes would provide a trader with greater confidence that the market in question will maintain that trajectory in the future.

Does volume support the wave on a market?

Another way you can use volume is through noting how it supports or doesn’t support each wave on a market. An uptrend with rising volumes on the upwards legs and falling volume on the retracements is expected to continue in that direction. However, it makes sense to be wary of an uptrend where volumes rise on the downward retracements, only to decline when the market moves higher.

Assessing market sentiment through volume

Ultimately this is a case of conviction, and a market move that is built upon low volumes is obviously less convincing than a widespread involvement in a round of buying. When volumes increase during a price rise, yet fall during a price drop, that is bullish. Conversely, if volumes increase during down moves, yet decrease during upward price moves, this would be a bearish signal.