Volume indicator, usually located below price chart, is often overlooked by traders. However, it actually could provide powerful assistance during trading in all market condition.
Volume indicator, usually located below price chart, is often overlooked by traders. However, it actually could provide powerful assistance during trading in all market condition. Although it could not accurately pinpoint entry and exit points, it is a good sidekick in determining the strength of a trend as well as when the trend ends.
The Strength Of A Trend
At its core, forex market is ruled by a simple law of supply and demands. Thus, how many transactions occur at any given time may determine price swings. When there are more buyers than sellers, then a currency will strengthen; but if the opposite happen, then a currency will weaken. But above all that, if a market is unattractive, then buyers and sellers will leave it; only to come later when things turn more attractive. Hence, the total amount of buyers and sellers in the market can adds up into an indicator of how exuberant is the market at a certain moment.
In a trending market, volume usually spikes. Note the volume indicator in an MT4 chart above and see how volumes contracted ahead of the news release, then slowly rose, and shot up if the news is particularly explosive. Contrarily, in a ranging market, the volume is usually low. For trend-following traders, these indications are important; after all, a ranging market is calm but it is very difficult to take advantage of it.
Beside of that, a deceptively calm market may render an entry signal useless, only for the market to turn the other way later when the signal is already out-of-date. Let's say our indicators have revealed a buy signal, so we enter the market to go long...but after some time, there is nothing going on. The market stays ranging for quite a long time, maybe an hour or two, after which volume started to rise and prices dropped. Instead of gaining advantage, we lose money. For trend-following traders, it is better to join a strong trend rather than a weak signal. This is where volume indicator will assist our decision making during trading.
The End of A Trend
Market condition changes from time to time, thus after some time a trending market may turn into ranging, a bearish market may bounce and turn into bullish, and vice versa. However, how do one know where one trend ends and another begin? With volume indicator, you can smell it.
See how prices fall after a volume spike in the picture above? Let's say we are in an auction where bids for an antique painting has reached its topmost price level, what will happen then? most likely, no one will bid again. The same can be said in the forex market. When a certain price is already considered too high, then many people will stop buying; instead, there will be many people who get out of the market or trying to cash in their profits. Thus, it can be concluded that after a substantial jump on volume, the previous trend will end. Afterward, what's left is for prices to consolidate in a fundamentally-sound level.
Just by knowing when the trend ends, we can know when to stop buying the currency. Afterward, in accordance with other technical indicators, we can decide to get out of the market, or instead, taking the opportunity to sell it off from a high.
That is two simple ways in utilizing volume indicator. Depends on what other indicators you use, it can be very useful, isn't it!? There are also many variations of this simple volume indicator, including On Balance Volume, Chaikin Money Flow, etc, and each can take the role of decision making assistance effectively in various other functions.