In my VWAP video, i talked about how and why institutional brokers trade at the VWAP line.
And how you can use that information to trade when the big players are trading. Volume on
a trading chart is pretty useless on its own. But if you connect the volume with the price
data, you will find some of the key levels on a trading chart and can spot where the
big players are trading. Individual traders with their small number of shares, can't make
a huge difference on a stock or Forex pair, but if you buy and sell where the big and
smart traders are trading, you will make more profit, because price tends to make a big
move when the institutional buyers enter the market.
But Before we learn how to find where the big money is at, we will first have to understand
how the volume actually works.
Lets say, bill buys 200 shares at 10 dollars, and bill the second sells 200 shares at 10
dollars. Since bill bought 200 shares and bill the second sold 200 shares at 10 dollars,
the volume traded at 10 dollars is 200. It is not 400. A lot of new traders think that
the volume is 400, since 200 plus 200 equals 400.
Purchasing few shares of a stock is very similar to purchasing few pencils from a shop. And
it is very similar to the math guy from the textbooks. When the math guy pays 200 dollars
to buy 200 watermelons, the sellers gives him 200 watermelons. The volume traded here
is 200, since the seller sold 200 watermelons, and the buyer bought 200 watermelons at 200
dollars.
Like i said before, this kinda of volume data on its own is pretty useless on a chart, unless
you also take price data into consideration.
Here's how to use the volume and price data together on a trading chart.
Number 1. When the price increases, and the volume also increases, the price is considered
to be bullish.
Number 2. When the price increases, but the volume decreases, the price is considered
to be bullish, but only the small traders are buying. Big players with their large amount
of shares are not buying.
Number 3. When the price decreases, but the volume increases, the price is considered
to be bearish.
Number 4. But when the price is decreasing and the volume is also decreasing, the price
is considered to be in a downtrend, but only the small traders are selling. Big players
are not participating in that move.
Now by increasing and decreasing volume, I'm not only talking about the volumes of individual
candles, but also the volumes of all the neighboring candles.
A lot of new traders, will only look at the volume of the candle that they are taking
the trade on, and not the volumes of other nearby candles.
Sometimes, beginner traders are told that they should pay attention to the volume when
the enter trades. If you enter on a candle and its volume rises, it is a good sign, as
there might be other traders entering at the same time. And if the volume does not rises,
your trade entry might be wrong.
This statement is kind of misleading. When you enter trade on a candlestick pattern,
there is no rule that the institutional buyers and other traders will or should take positions
by looking at the same candle. So the chances of volume rising at the same time you take
the position is highly unlikely. If many traders are interested in buying at the same area
as you are, you will see increase in volume near your entry area, and not on your entry
candle only.
Since institutional buyers trade in very high quantities, price tends to make sudden big
moves, when the big players enter the market. On smaller time frames, these sudden movements
can easily take out your stop loss. But if you spot the increase in volume at the right
time, you should take this opportunity by taking a position. If you get lucky, you will
ride the whale.
One of the situations where finding higher volume is really helpful, is during the formation
of the engulfing candlestick patterns.
A bullish engulfing pattern is a candlestick pattern that forms when the smaller than average
red candle is followed by a large green candle. This green candle is so big that it covers
or engulfs the entire body of the previous candle. Bullish engulfing pattern indicates
a possibility of price moving higher. A bearish engulfing pattern is just opposite
of the bullish engulfing pattern.
Not all engulfing patterns are worth trading. To filter out false engulfing signals, you
should take a look at the volume.
Let me give you an example.
Lets say, you are waiting for the price to reach a support level. To make sure the support
has a high chance of working, you look at the volume.
As the price is coming down to your support area, you see the volume decreasing. When
it touches your support area, a bullish engulfing pattern is formed. An Engulfing pattern is
a good sign as it indicates a reversal. But this one is even better, because this bullish
engulfing pattern has higher than average volume on the green candle.
This means that there is high buying demand near the support area you drew. After this
engulfing pattern, there is a high chance that the price will move higher.
In this example, you saw the decreasing volume near the support area. But what if it had
kept increasing even after touching your area?
If you saw the price moving down towards your support with higher volume. It indicates a
bearish pressure. In simple words, there is still a demand for selling near your support
area. If this is the case, the probability of your support area working and price reversing
are very low.
Volume can also help you identify the false breakouts. If price is in a range for a while
with a low volume, and you see a breakout with an average volume, it indicates a possibility
of it being a false breakout. But if a candle breaks out of a range with higher than average
volume, the chances of price moving further in the breakout direction becomes higher.
If you are trading using the volume, here are some important points you should note.
Number 1. Volume can be used to analyse the market trend, and reversals and your support
and resistance levels. Further more, volume can also be used to make sure the pullbacks
in a trend, are actual pullback and not reversals.
In an uptrend, if price is moving higher, and gives a pullback with lower volume, it's
a sign that price can still move upwards. But if the pullback has higher than average
volume, it can indicate a start of a new downtrend.
Number 2. Volume can also be used to find the smart money and the dumb money. If price
increases and volume increases, it a bullish trend. If price increases, but volume decreases.
It's a bullish trend, but there is no smart money participating. If price is decreasing,
but the volume is increasing, it's a bearish trend. If the price is decreasing, but the
volume is also decreasing, its a bearish trend with dumb money. Big players are not participating
in this move.
Number 3. Avoid trading on low volume days and take trades on higher volume days.
Number 4. Volume can be a lot higher and price movement can be more volatile on stocks during
events or news releases. If you trade on smaller time frames, you should keep an eye on these
news releases that impact the volatility.
Number 5. Volume is usually higher during market openings and closing, and is low during
lunch hours. If you are a beginner, you should probably avoid trading during lunch hours
and only trade when the market is trending with a high volume.
That's all. Now you know a little bit more about volume in trading.
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