What is Volume?
Volume is the number of a given financial asset such as shares of a stock, bonds, cryptocurrencies, options and futures contracts are traded in a specified period of time. This specified period can range from 1 minute charts to daily charts.
Each price chart for that particular time frame (daily in the example below) prints the volume bars in green or red. The green bars indicate a higher closing price for that time period while a red bar means that the cryptocurrency closed lower for that period. These colour codes have got nothing to do with the volume traded. If you look at the example below, even when the closing price was lower on August 2, 2020, the volume traded was higher than that for the previous day. Looking at the pattern of volume traded in a particular market talks about its strength and the conviction that people have about that market.
Trading volume is often used by traders as an indicator to confirm the existence or continuation of a trend or a trend reversal. This helps traders decide whether the investment is a good option or not. Let us take a deeper look at how these things are related.
Volume and Market Strength
The volume of a financial asset that is being traded in a particular time period speaks a lot about its importance among investors. High volume usually means that a larger number of traders are participating in the market. A greater reliance can be placed on the price movement in a market where high volume is traded than in a market for low volume. This further reduces the spread between the bid and ask prices due to increased liquidity.
High volumes also act as a characteristic of a market trend. For example, in case of a false alarm traders might panic sell a particular cryptocurrency leading to large volumes getting sold quickly. This may lead to the beginning of a downward trend in the market.
Low volumes on the other hand indicate that the participants are not confident about a particular cryptocurrency and this leads to the price getting consolidated within a sideways trading range.
Volume therefore is a useful way in understanding the market sentiments.
Volume and Price Movement
The trading volume indicates the strength or momentum of a price movement. This means that a price movement in the upward or downward direction is always more significant when traded in high volumes. In case the price is rising with low volumes being traded, this implies that the uptrend may be temporary.
Current trading volume and average trading volume are important characteristics in understanding the market. Average trading volume usually decreases when a cryptocurrency is in a downtrend as traders view cryptocurrencies in a negative way when the price declines.
An increasing price is often coupled with increasing volume but the price may decrease without any increase in volume if traders lose interest in that crypto. Similarly, a declining price is also coupled with higher volume. This might happen when negative news about the crypto gets spread in the market.
There are a few basic rules you could follow to improve your trading. This has been summarised as follows:
- If the price is increasing or decreasing with increased volumes then the trend is gathering strength.
- If the price is increasing or decreasing with reduced volumes then there is a possibility of a trend reversal.
Guidelines for Traders
It is very common for traders to participate in markets which show strong (increasing volume) price moves. Traders even enter positions in the opposite direction in markets with decreasing volumes. Here are a few guidelines on using volume that the traders could follow to improve their trading :
As easy as it could be explained, a rise or fall in price of a cryptocurrency accompanied by little trading volume has little significance. On the other hand, a market with higher volume gives stronger signals to its traders.
Exhaustion is a situation in which a majority of participants trading in the same asset are either long or short, leaving few investors to take the other side of the transaction for the other traders who wish to close their positions. Exhaustion is reached when the asset does not have the support from buyers or sellers to continue moving up or down respectively. Exhaustion indicates whether a market is overbought or oversold and it is in this case that a trend reversal takes place.
Identifying exhaustion could be done in various ways. One of them is by analysing the futures market. If there are a large number of long contracts, it means that there are a large number of buyers and the asset is probably oversold. If we feel that all those who wanted to go long have already done so and there are no more buyers, this would lead to sellers becoming more aggressive. This may lead to a potential trend reversal.
Even for exhaustion there could be 2 types –
- Where buyers keep buying a cryptocurrency in an uptrend and the trading volume gradually keeps decreasing till it reaches its peak.
- A blow-off top which means that the price of a cryptocurrency increases rapidly along with rising trading volume followed by a steep and rapid drop in price usually on significant or high volume as well.
A similar explanation could be given for fall prices for the 2 types of exhaustion.
The movement of price along with the volume is an important way for traders to identify a bullish market. For example, if the price of a cryptocurrency is falling with increasing volume and it rises and falls again, check whether the new low is higher than the previous low. If that is true and the volume has diminished on the second decline, then this is usually interpreted as a bullish sign.
Real vs. False Breakouts
If the breakout in the price chart takes place with a high volume in the market, this means that the breakout has the potential to be a real one. Little change or a fall in volume on the other hand means that the breakout is probably a false one.
Although ignored by many beginners, trading volume is one of the most important technical parameters that traders can use in any market. Not only is it used to determine the market strength which talks about the liquidity, momentum and other factors, it is also used to confirm whether a breakout is for real or not. Volume traded and price movement is also an important factor in determining whether the market will be bullish or bearish or whether there is a potential trend reversal possible. While volume analysis is an important tool, traders must not solely depend on them to enter and exit markets.
For the reader
Some of the commonly used volume indicators are OBV, Volume RSI, Volume price trend indicator, Chaikin money flow indicator and Klinger Oscillator.
Find out more about the above indicators in our coming blogs on DCX Learn.