In today's article we will look at how volume works in Forex. If you've traded stocks before, you probably understand how volume can be used to identify potential trading opportunities. Since volume is more obvious in stock trading, let's look at how volume can help forex traders.
What does trading volume tell us?
If you don't know anything about volume, let's first look at how stock trading volume works because in this market it is much easier for us to explain the concept.
Stock trading volume is simply a measure of how many shares are traded during each candle. For example, in this daily chart, 24,157,000 shares (rounded) were traded over the last day.
This can be key information when trading stocks. But we also need other information.
How many shares are outstanding?
It is very useful to know the total number of shares that are traded on the exchange. This is called a float.
When we check Yahoo Finance, we find that the total number of shares outstanding is 1.33 Billion shares. In stock trading, this is important because it helps us answer the question: “How much volume is high volume?”
So in this example, 24 million shares is not a lot of volume compared to the 1.33 billion shares that are available for trading.
Now, if there was a day when 600 million shares were traded, that's almost half the total number of shares, and that would tell us that something very important is happening to the stock. This brings us to some other clues that trading volume can give us.
Let's look at three main ways to use volume to identify trading opportunities.
Volume can show you market depletion
When you see higher volume as the price declines, it means investors are dumping the stock, and it could be a signal that it's time to sell off your shares too. Without a lot of volume, the price drop may just be a short-term dip before it moves up again.
A few big drops on high volume can also signal a good buying opportunity. If you think the company is solid but has simply been the victim of bad short-term news, this could be a great time to buy at a very low price.
In other words, it could signal a market bottom.
Let's look at Citigroup during the aftermath of the 2007 financial crisis. During 2008 the price decreased. Then, by early 2009 (points 1 and 2 below), we saw two large spikes in volume during two down days.
Let's look at volumetric analysis. There was some buyer interest at point #3, but the price did not increase significantly. Buyers step in to buy shares for short-term gain. However, at location #4 there was another huge jump in sales volume, but the price did not drop significantly. This was a sign that most sellers were out of stock at the time.
This is how we can use volume to show us when a stock has no more buyers and is ripe for buying.
Volume can show you accumulation
Volume can tell you when stock accumulation is possible. In the basic example there are more green bars than red bars on the volume indicator. So this could be a good hint that the price may start to turn around soon.
Volume can show the strength of movement
The general idea is that if you see an increase in volume in a trend, it is likely that you will continue to see price movement in the same direction. This makes sense because as a trend gains momentum, more people need to join in to keep the trend going.
Here is an example of a trend in oil where volume increases with an upward trend. Although these are futures and not stocks, the same principle applies. Once volume begins to dry up, the trend reverses shortly thereafter.
How does volume work in Forex?
After reading the previous examples, you are probably ready to add a volume indicator to your forex charts. Wait a minute because volume works a little differently in Forex.
First, it is impossible to determine how much of a currency is traded each day. This is because forex trading is a decentralized market.
Since there is no primary exchange through which all transactions pass, it is impossible to calculate how much currency is traded at one time. So, what you see on your charts is only the volume that your broker sees. This can result in very different numbers between brokers.
For example, here are two screenshots for EURUSD taken at the same time. This chart uses Oanda data and shows that the current volume is 8,156 currency units.
But when we look at the FXCM chart, we see a completely different picture. This chart shows a volume of 50,869 currency units.
If you look at relative volume, the charts are very similar, but not exactly. For example, the right side of this graph shows a large spike. However, the Oanda chart actually shows a decrease in volume.
Does this mean volume is useless in forex trading? Well, let's look at some examples to see if this can be useful, even if you only see part of the picture.
Market exhaustion
As you can see, the price declined on heavy volume but settled below the previous support point. After this surge in volume, the price began to move up.
This is an example of a fairly long downtrend followed by an underlying pattern and an increase in volume. An increase in volume could be a sign that accumulation is occurring. Soon after, the price rose sharply.
Trend strength
Here's an example I've found where a strong trend is reinforced by volume. As we saw with oil above, when volume begins to decrease, the price begins to fall.
Lower timeframes
Based on those previous examples, volume in forex can be a pretty useful predictor of future price movement. But wait a minute, those were some well-chosen examples. What happens if you choose a different time slot? For example, a 4-hour chart? Here's what you'll see.
Differences in market opening times and volume are reflected in intraday volume spikes. However, if you only take spades, it will be usable.
Let's sum it up
Forex volume can give us some clues about where the price might go next. However, since we only see volume from one broker, it is difficult to trust the numbers to give us an accurate picture of how much currency is traded in the entire market.
If you want to test a trading strategy that includes volume as a trading signal, be sure to use data from the broker you will be trading with. It is very important.
There are times when volume can signal the possible direction of the market, but for the most part volume is too flat to make any real trading decisions. Check it out and see for yourself.
