Trading, Volume as Indicator: what is it and how does it work

10 November 2022 - 14:18

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Recently, many are using volume as an indicator. Let’s see how it works together.

Trading, Volume as Indicator: what is it and how does it work

Trading envisages, especially in the market analysis phase, the use of tools that help the trader to delineate in more depth the market movement that he wishes to examine. In this context, the use of indicators and oscillators could be fundamental for some, especially for those who have a very technical approach.

In addition to the classic indicators and oscillators, those that we usually find by default within an operating platform, there are other very useful tools that use a "different" approach to the classic one. The use of volume as an indicator has become relatively famous.

It is an indicator that absolutely must be used in some phases of the analysis and which could help to better clarify some market phases, especially in identifying target levels of movement and which could subsequently be used as support or resistance. Basically, volume is a very useful tool but it has some criticalities that come to light when you use it as a “main” tool. So let’s see together what the volume is, its criticalities and its use.

Volume as an indicator: what is it?

The volume indicates the quantity traded within a time frame, or in some cases, within certain price ranges. As we can already see from what has been said, the volume can be used "vertically", that is seeing vertical bars that refer to the exchanges that take place in a given time frame, or used "horizontally", seeing horizontal bars indicating the quantity traded within a given price range. It is interesting to underline the fact that the volume does not indicate the number of trades, ie the number of transactions carried out, but indicates the quantities traded.

To give an example, we can find a number of transactions equal to two within a specific time frame. Having done this, however, we need to know the extent of these two transactions which could be very different from each other. Well, the volume indicator tells us the amount traded in these two transactions. Having said that, we obviously need to identify how we want to measure trades, ie whether to measure volumes at time level or at price level. In these two cases, the information that the indicator provides us is of a different nature and it is at the trader’s discretion which one to use for his purposes. Let’s see the difference between the two pieces of information together.

Time volume

The volume used with vertical bars is the standard volume indicator found on most platforms. Given a time frame, it tells us the quantities traded for that time frame. To give an example, on a time frame at 5 minutes, the volume indicator will tell us the quantities traded every 5 minutes, there is a volume bar for each candle that we find on the chart. What information does it provide us with? According to the more “mainstream” interpretations, we can affirm that a higher trading volume corresponds to a higher interest for that particular asset, while a lower interest corresponds to low volumes.

When we see volumes falling on a bearish trend, then it will probably mean that the trend is reversing and so, consequently, if the trend is bearish and the volumes are increasing the trend could continue. But is there a logical sense in these statements? Absolutely not, indeed, the volume indicator does not give any information about the directionality of an asset but only tells us that more trades have occurred in a given time frame.

Buying volumes and selling volumes

Surely you have also heard of “volumes in purchase" and "volumes in sale", an externalization that refers to the fact that a certain number of volumes corresponds to an increase in the price or a decrease in the same. This terminology is absolutely misleading and in no way contributes to establishing whether there are any volumes to buy or to sell. Indeed, the exchange provides that a purchase quantity corresponds to a corresponding sale quantity. This belief that there are volumes to buy or volumes to sell is absolutely misleading at an operational level, therefore it is not applicable and could be a theory that complicates the analysis rather than improving the overview.

The volume-price

The volume-price indicates with horizontal bars the trades that took place in certain price ranges. This indicator is particularly used above all to identify any supports and resistances, or rather, to confirm important market levels. At an operational level it could be interesting to use this indicator as confirmation of certain levels identified a priori through classical technical analysis.

In some cases the volume-price indicator is summarized with another indicator that refers to prices which is the Volume Profile, that is a volumetric profile that we find directly on each candle of a chart. This indicator is widely used in intraday trading, with instruments mainly listed on regulated markets where the levels identified by the Volume Profile are used.

Criticality of the volume indicator

The volume indicates, as the word itself says, the number of quantities exchanged and nothing else. It does not provide actual operational indications unlike other indicators and oscillators. Obviously, as an indicator it is valid when it is contextualized to the scenario under consideration. To give an example, the volume-price indicator can be used for confirm levels but it does not provide any indication about the direction of the movements, therefore when you hear the use of the volume indicator as a determining factor in establishing the performance of a specific financial instrument, we must ask ourselves doubts about the veracity of what is professed.

Therefore, beyond the volume indicator, every tool that helps the trader to evaluate scenarios must be used with caution, i.e. with knowledge of the facts and avoid being hasty in wanting to find the solution to a problem that is upstream, identifiable in the analysis process prior to the use of the indicators and any supporting tool.

Original article published on Italy 2022-11-10 08:57:00.
Original title: Trading, il volume come indicatore: cos’è e come funziona

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