Chapter 7: Volume Analysis in Forex

Introduction

Volume analysis is a powerful technique that adds a crucial dimension to forex trading by revealing the strength and conviction behind price movements. While volume data in forex differs from exchange-traded markets due to its decentralized nature, modern trading platforms provide reliable volume indicators that can significantly enhance your trading decisions.

In this chapter, we’ll explore how to effectively incorporate volume analysis into your forex trading, understand the relationship between volume and price, and develop strategies that leverageThe ability to control a large amount of money in the Forex market with a smaller amount of capital. Expressed as a ratio (e.g., 50:1). volume patterns to identify high-probability trading opportunities.

Understanding Volume in Forex Markets

Unlike stock markets where volume represents the actual number of shares traded, forex volume metrics are derived differently due to the market’s decentralized structure:

Types of Forex Volume Metrics:

Tick Volume:

Counts the number of price changes (ticks) within a specific time period
Serves as a proxy for actual trading volume
Available on most trading platforms including MetaTrader

Futures Volume:

Volume data from currency futures markets (e.g., CME)
Provides a reliable approximation of spot forex volume
Shows institutional participation more clearly

Broker-Specific Volume:

Volume data from a specific broker’s client transactions
Limited to that broker’s market share
Useful for identifying retail trader positioning

Bank-Reported Volume:

Aggregated volume data from major banks and ECNs
Available through specialized platforms and services
Most accurate but often not accessible to retail traders

Correlation with Actual Trading Activity:

Despite the indirect nature of forex volume metrics, research has shown strong correlation between tick volume and actual trading activity, making it a valid analytical tool when used properly.

Core Volume Analysis Principles

1. Volume-Price Relationship

The fundamental principle of volume analysis is understanding how volume interacts with price:

Confirming Volume:

Rising prices with increasing volume suggests strong buying pressure
Falling prices with increasing volume suggests strong selling pressure
These scenarios indicate trendThe general direction in which a market is moving (uptrend, downtrend, sideways trend). continuation is likely

Non-Confirming Volume:

Rising prices with decreasing volume suggests weakening buying pressure
Falling prices with decreasing volume suggests weakening selling pressure
These scenarios often precede reversals or consolidation

Climactic Volume:

Extremely high volume spikes often indicate exhaustion
May signal the end of a trendThe general direction in which a market is moving (uptrend, downtrend, sideways trend). and potential reversal
Particularly significant at major supportA price level where buying interest is strong enough to prevent the price from falling further./resistance levels

2. Volume Patterns

Specific volume patterns provide valuable insights into market dynamics:

Volume Expansion:

Sudden increase in volume after a period of low volume
Signals increased interest and potential for significant price movement
Often occurs at the beginning of new trends or breakouts

Volume Contraction:

Decreasing volume during price consolidation
Indicates diminishing interest and potential energy building
Often precedes significant price movements

Volume Divergence:

When volume trendThe general direction in which a market is moving (uptrend, downtrend, sideways trend). moves in the opposite direction of price trendThe general direction in which a market is moving (uptrend, downtrend, sideways trend).
Signals potential weakness in the current price movement
Example: Price making new highs with decreasing volume suggests diminishing buying pressure

3. Volume at Support/Resistance

Volume behavior at key price levels provides crucial context:

High Volume at SupportA price level where buying interest is strong enough to prevent the price from falling further.:

Indicates strong buying interest defending the level
More likely to hold as supportA price level where buying interest is strong enough to prevent the price from falling further.
Often creates stronger bounces when respected

High Volume at ResistanceA price level where selling pressure is strong enough to prevent the price from rising further.:

Indicates strong selling interest at the level
More likely to hold as resistanceA price level where selling pressure is strong enough to prevent the price from rising further.
Often creates sharper rejections when respected

Low Volume at SupportA price level where buying interest is strong enough to prevent the price from falling further./Resistance:

Suggests lack of conviction at the level
More likely to be broken
Often leads to false breakouts or weak reactions

Volume Indicators for Forex Trading

Several indicators can help visualize and interpret volume data:

1. Volume Bars/Histogram

The most basic volume indicator displaying raw volume data:

Interpretation:

Compare current volume to recent average volume
Look for significant deviations from normal volume
Pay attention to volume spikes at key price levels

Advanced Usage:

Color-code volume bars based on price direction (up/down)
Compare volume across multiple timeframes
Identify patterns like ascending/descending volume

2. On-Balance Volume (OBV)

A cumulative indicator that adds volume on up days and subtracts volume on down days:

Calculation:

If today’s close > yesterday’s close: OBV = Previous OBV + Today’s Volume
If today’s close < yesterday’s close: OBV = Previous OBV – Today’s Volume
If today’s close = yesterday’s close: OBV = Previous OBV

Interpretation:

Rising OBV suggests accumulation (buying pressure)
Falling OBV suggests distribution (selling pressure)
OBV divergence from price often precedes reversals

Trading Applications:

OBV trending higher before price breakout suggests strong potential upside
OBV trending lower before price breakdown suggests strong potential downside
OBV holding steady during price pullbacks suggests healthy correction

3. Volume-Weighted Average Price (VWAP)

A weighted average price that factors in both price and volume:

Calculation:

VWAP = ∑(Price × Volume) ÷ ∑(Volume)

Interpretation:

Price above VWAP suggests bullish sentiment
Price below VWAP suggests bearish sentiment
Price repeatedly respecting VWAP as supportA price level where buying interest is strong enough to prevent the price from falling further./resistance confirms its significance

Trading Applications:

Institutional traders often use VWAP for entry/exit decisions
Retail traders can use VWAP as a trendThe general direction in which a market is moving (uptrend, downtrend, sideways trend). filter
VWAP can identify potential intraday supportA price level where buying interest is strong enough to prevent the price from falling further./resistance levels

4. Money Flow Index (MFI)

An oscillator that combines price and volume to measure buying and selling pressure:

Calculation:

Calculate Typical Price: (High + Low + Close) ÷ 3
Calculate Raw Money Flow: Typical Price × Volume
Calculate Money Flow Ratio over 14 periods
Scale to 0-100 range

Interpretation:

MFI > 80: Overbought conditions
MFI < 20: Oversold conditions
Divergence between MFI and price suggests potential reversal

Trading Applications:

Use MFI divergence to identify potential trendThe general direction in which a market is moving (uptrend, downtrend, sideways trend). reversals
MFI crossing above 20 from below can signal buying opportunity
MFI crossing below 80 from above can signal selling opportunity

5. Volume Profile

A horizontal histogram showing volume distribution across price levels:

Components:

Value Area: Price range containing 70% of trading volume
Point of Control (POC): Price level with the highest volume
High Volume Nodes: Price levels with significant volume
Low Volume Nodes: Price levels with minimal volume

Interpretation:

POC often acts as significant supportA price level where buying interest is strong enough to prevent the price from falling further./resistance
Price tends to move quickly through low volume nodes
Price tends to consolidate at high volume nodes

Trading Applications:

Identify potential supportA price level where buying interest is strong enough to prevent the price from falling further./resistance levels based on volume clusters
Look for breakouts from low volume areas
Use value area boundaries for range-trading strategies

Advanced Volume Analysis Techniques

1. Volume Spread Analysis (VSA)

VSA examines the relationship between price spreadThe difference between the ask price and the bid price of a currency pair, representing the transaction cost for the trader. (range), closing price, and volume:

Key VSA Principles:

Large spreadThe difference between the ask price and the bid price of a currency pair, representing the transaction cost for the trader. up bar with high volume closing near high: Strong buying
Large spreadThe difference between the ask price and the bid price of a currency pair, representing the transaction cost for the trader. down bar with high volume closing near low: Strong selling
Narrow spreadThe difference between the ask price and the bid price of a currency pair, representing the transaction cost for the trader. bar with high volume: Potential absorption and reversal
Wide spreadThe difference between the ask price and the bid price of a currency pair, representing the transaction cost for the trader. bar with low volume: Potential lack of conviction

VSA Patterns:

Demand Coming In:

Down bar with high volume closing mid-range or higher
Indicates selling being absorbed by strong buying
Often precedes upward price movement

Supply Coming In:

Up bar with high volume closing mid-range or lower
Indicates buying being absorbed by strong selling
Often precedes downward price movement

No Demand:

Up bar with low volume
Indicates lack of buying interest
Often precedes failed rallies or reversals

No Supply:

Down bar with low volume
Indicates lack of selling interest
Often precedes failed declines or reversals

2. Relative Volume Analysis

Comparing current volume to historical averages provides context:

Volume Moving Averages:

20-period volume MA shows short-term average volume
50-period volume MA shows intermediate-term average volume
Volume significantly above these averages indicates unusual interest

Volume Percentage Change:

Calculate percentage increase/decrease from previous periods
Identify abnormal volume spikes or contractions
Use thresholds (e.g., 200% of average) to identify significant events

Time-Based Volume Patterns:

Analyze volume patterns at specific times (session opens/closes)
Identify regular volume patterns around news events
Compare current volume to typical volume for that time of day

3. Volume-Based Support and Resistance

Using volume data to identify significant price levels:

Volume by Price:

Horizontal histogram showing cumulative volume at each price level
Identifies price levels with highest historical trading activity
These levels often act as supportA price level where buying interest is strong enough to prevent the price from falling further./resistance in future trading

Volume Nodes:

Areas of high volume concentration
Often represent fair value areas where significant trading has occurred
Price tends to return to these areas after moving away

Volume Gaps:

Areas with minimal historical volume
Price tends to move quickly through these zones
Often create “vacuum” effects where price accelerates

4. Wyckoff Volume Analysis

Richard Wyckoff developed sophisticated methods for analyzing volume:

Accumulation Phase:

Preliminary SupportA price level where buying interest is strong enough to prevent the price from falling further. (PS): Initial supportA price level where buying interest is strong enough to prevent the price from falling further. with increased volume
Selling Climax (SC): Extreme selling with very high volume
Automatic Rally (AR): First significant bounce with moderate volume
Secondary Test (ST): Retest of lows with lower volume than SC
Spring: Final shakeout with low volume relative to previous tests

Distribution Phase:

Preliminary Supply (PSY): Initial resistanceA price level where selling pressure is strong enough to prevent the price from rising further. with increased volume
Buying Climax (BC): Extreme buying with very high volume
Automatic Reaction (AR): First significant pullback with moderate volume
Secondary Test (ST): Retest of highs with lower volume than BC
Upthrust: Final shakeout with low volume relative to previous tests

Practical Volume Trading Strategies

1. Volume Confirmation Strategy

Setup:

Identify a potential trendThe general direction in which a market is moving (uptrend, downtrend, sideways trend). or breakout using price action
Look for confirming volume patterns
Ensure volume is increasing in the direction of the breakout

Entry:

Enter when price breaks supportA price level where buying interest is strong enough to prevent the price from falling further./resistance with above-average volume
Confirm with strong closing price near the extreme of the bar
Look for follow-through volume in subsequent bars

Stop Loss:

Place stop loss beyond the recent swing point
Alternative: Place stop beyond a significant volume node

Take Profit:

Target the next significant volume-based supportA price level where buying interest is strong enough to prevent the price from falling further./resistance
Consider trailing stops based on volume behavior

2. Volume Divergence Strategy

Setup:

Identify divergence between price and volume indicators (OBV, MFI)
Price making new highs/lows while volume indicators fail to confirm
Look for additional technical confirmation (candlestick patterns, etc.)

Entry:

Enter when price begins reversing from the extreme
Confirm with reversal candlestick pattern
Look for increasing volume on the reversal move

Stop Loss:

Place stop loss beyond the recent price extreme
Size position based on this stop placement

Take Profit:

Target previous swing points
Consider multiple targets with partial position exits

3. Volume Climax Reversal Strategy

Setup:

Identify unusually high volume spike (200%+ above average)
Look for wide-range candle at supportA price level where buying interest is strong enough to prevent the price from falling further./resistance level
Confirm with subsequent price rejection

Entry:

Enter after the climax bar when price begins reversing
Confirm with decreasing volume on pullback
Look for reversal candlestick pattern

Stop Loss:

Place stop loss beyond the climax bar
Alternative: Place stop beyond the next significant volume level

Take Profit:

Target the origin of the climactic move
Consider trailing stops to capture extended moves

4. Volume Profile Trading Strategy

Setup:

Create volume profile for relevant trading period
Identify Point of Control (POC) and Value Area boundaries
Look for price approaching these significant levels

Entry:

Enter when price reacts at POC or Value Area boundary
Confirm with rejection candlestick pattern
Look for increasing volume on the reaction

Stop Loss:

Place stop loss beyond the nearest low volume node
Alternative: Place stop beyond the Value Area

Take Profit:

Target the opposite boundary of the Value Area
Consider targeting the next significant volume node

Implementing Volume Analysis in Your Trading

Required Tools and Data

To effectively implement volume analysis, you’ll need:

Trading Platform Requirements:

Access to reliable volume data (tick volume at minimum)
Volume indicator capabilities
Volume profile functionality (available on advanced platforms)

Recommended Platforms:

TradingView (Premium)
MetaTrader with enhanced volume indicators
NinjaTrader
Sierra Chart

Integration with Price Action

Volume analysis works best when integrated with price action:

Complementary Approach:

Use price action to identify potential setups
Use volume to confirm or reject these setups
Prioritize setups where price and volume align

Practical Integration:

Identify key supportA price level where buying interest is strong enough to prevent the price from falling further./resistance levels using price action
Confirm these levels with volume analysis
Look for volume patterns at these levels
Make trading decisions based on the combined analysis

Developing Volume Reading Skills

Volume analysis requires practice to master:

Skill Development Process:

Begin by observing volume patterns without trading
Document relationships between volume and subsequent price movements
Practice identifying specific volume patterns
Implement with small position sizes
Scale up as proficiency increases

Practice Methodology:

Review historical charts with volume overlay
Identify volume patterns and note subsequent price action
Create a journal of volume observations
Test hypotheses about volume behavior
Refine your understanding through continuous observation

Case Study: EUR/USD Volume Analysis

Let’s analyze a real-world example on the EUR/USD 4-hour chart:

Scenario:

EUR/USD in a downtrend on the daily timeframe
Price approaches a major supportA price level where buying interest is strong enough to prevent the price from falling further. level on the 4-hour chart
Large volume spike occurs at supportA price level where buying interest is strong enough to prevent the price from falling further. with a hammer candlestick
Volume decreases on subsequent test of the same level
OBV begins trending higher despite price making a lower low

Analysis:

The high volume spike at supportA price level where buying interest is strong enough to prevent the price from falling further. suggests strong buying interest
Decreasing volume on the retest indicates weakening selling pressure
OBV divergence confirms potential reversal
The hammer candlestick provides additional price action confirmation

Trading approach:

Enter long position after confirmation of supportA price level where buying interest is strong enough to prevent the price from falling further. holding
Place stop loss below the lower low
Set initial target at the previous swing high
Move stop to breakeven after price moves 1:1 risk-reward
Consider partial profit-taking and trailing stops for remaining position

Conclusion

Volume analysis provides a crucial dimension to forex trading by revealing the conviction behind price movements. By understanding the relationship between volume and price, traders can make more informed decisions about trendThe general direction in which a market is moving (uptrend, downtrend, sideways trend). strength, potential reversals, and optimal entry/exit points.

Remember that volume analysis is most effective when:

Used in conjunction with price action and other technical tools
Applied with an understanding of its limitations in the forex market
Interpreted within the context of the current market environment
Practiced consistently to develop pattern recognition skills

As you incorporate volume analysis into your trading, start with the basic concepts and gradually add more sophisticated techniques. With practice, you’ll develop an intuitive understanding of how volume influences price movement, giving you a significant edge in your forex trading.

In the next chapter, we’ll explore the Wyckoff Method for Forex Trading, which builds upon many of the volume concepts discussed here to create a comprehensive framework for market analysis.

Key Takeaways

Volume reveals the conviction behind price movements, adding a crucial dimension to technical analysisA method of forecasting future price movements based on the study of historical price data, charts, and indicators.
In forex, tick volume serves as a reliable proxy for actual trading activity
Confirming volume (increasing in the direction of the trendThe general direction in which a market is moving (uptrend, downtrend, sideways trend).) suggests trendThe general direction in which a market is moving (uptrend, downtrend, sideways trend). continuation
Non-confirming volume (decreasing in the direction of the trendThe general direction in which a market is moving (uptrend, downtrend, sideways trend).) often precedes reversals
Volume spikes at supportA price level where buying interest is strong enough to prevent the price from falling further./resistance provide valuable information about level strength
Volume indicators like OBV, MFI, and Volume Profile help visualize volume patterns
Volume divergence from price often precedes significant reversals
Volume analysis is most effective when combined with price action and other technical tools