Understanding Volume Analysis Techniques
Volume analysis is a crucial aspect of technical analysis, helping traders to understand the strength of price movements. In this article, we will delve into the various volume analysis techniques, providing you with a comprehensive understanding of this essential trading strategy.
What is Volume Analysis?
Volume analysis refers to the study of the number of shares or contracts traded in a security or an entire market during a given period. It is often plotted as a histogram underneath the price chart. The basic premise is that volume precedes price. Hence, if a security is in an uptrend, it should ideally be accompanied by increasing volume.
Key Volume Analysis Techniques
On-Balance Volume (OBV)
On-Balance Volume is a momentum indicator that uses volume flow to predict changes in stock price. Joseph Granville developed the OBV metric in the 1960s. He believed that when volume increases sharply without a significant change in the stock’s price, the price will eventually jump upward, and vice versa.
Volume by Price
Volume by Price is a chart overlay that shows the amount of volume for a particular price range, which is based on closing prices. This technique helps traders to identify supply and demand levels.
Volume Oscillator
The Volume Oscillator displays the difference between two moving averages of a security’s volume. The two lengths can be customized, and the Volume Oscillator is expressed as a percentage. This technique can help traders identify bullish or bearish divergences.
Chaikin Money Flow
Developed by Marc Chaikin, Chaikin Money Flow (CMF) is a volume-weighted average of accumulation and distribution over a specified period. The standard setting is 21 periods, but this can be adjusted to suit different trading strategies.
Importance of Volume Analysis
Volume analysis provides traders with significant insights into the strength and sustainability of a particular price move. Here are some reasons why volume analysis is important:
Confirmation of the Trend
A rising market should see rising volume. Buyers require increasing numbers and increasing enthusiasm to keep pushing prices higher. Increasing price and decreasing volume show lack of interest, and this is a warning of a potential reversal. This can be hard to wrap your mind around, but the simple fact is that a price drop (or rise) on little volume is not a strong signal.
Exhaustion Moves and Volume
In a rising or falling market, we can see exhaustion moves. These are generally sharp moves in price combined with a sharp increase in volume, which signal the potential end of a trend. Participants who waited and are afraid of missing more of the move pile in at market tops, exhausting the number of buyers.
Volume and Breakouts
Volume can help to validate all kinds of breakouts. When the market breaks a resistance or support level with a significant increase in volume, the breakout is seen as stronger and more relevant.
Conclusion
Understanding volume analysis techniques can significantly enhance your trading strategies. It provides insights into market sentiment and potential reversals, helping you make more informed trading decisions. However, like any other market analysis method, it should not be used in isolation. Traders should use volume analysis in conjunction with other indicators and technical analysis tools to increase the odds of a successful trade.
