The Importance of Volume In Technical Analysis For Forex Trading
Though we have said that technical analysis focuses on price and volume, we have said relatively little about the role of volume so far. Volume is simply the number of contracts traded over a given period of time usually one day.
The higher the volume, the more active the forex trading. Analysts look at the volume bars that are usually shown at the bottom of any chart and show the movement and trends just like prices…
Volume plays an important role in technical analysis because it can be used to confirm trends or patterns on charts. Any price movements that are accompanied by high volumes are seen to be more significant and sustainable than price movements with low volumes. So if you are examining a large price movement, you will want to cross check your conclusions with volume data. For instance, if a currency price jumps after a long steady downward trend, a large volume will indicate a probable trend reversal. If, on the other hand, the volume is modest, you may not be looking at a true reversal.
The volume should move hand in hand with the trend. In other words, rising prices should be accompanied by increasing volumes. If this is not the case, you are probably looking at a weak trend. If rising prices continue to be accompanied by low volumes, your trend is probably running out of steam. When volume differs from price, the phenomenon is known in technical analysis as divergence.
Volumes and chart patterns: technical analysts also regard volume data is critical in confirming patterns on the chart. In most chart patterns such as head and shoulders or flags, there are certain key points on the chart that need to be confirmed by volume data. Basically if the volumes do not confirm the patterns, chartists regard it as an inferior quality signal.
Volume precedes price: a fundamental belief in technical analysis is that price changes are always preceded by changes in volume. And chartists therefore study volume data closely in order to identify the reversals in trends. When volume begins to taper off when prices are rising, it is a sign that that the uptrend is faltering.
As we said earlier, seasoned analysts and forex brokers always look for confirmation of patterns from the volumes. True breakouts above support levels are almost always accompanied by higher than normal trading volume. You may ask why you should worry about volume when prices of a currency in which you are long are rising. After all, few things match the thrill of getting the price movement in the market right. However, don’t let the magic of rising prices distracting from the duties of technical analysis. If the uptrend is healthy, volumes will keep rising as prices rise because buyers will be going long in the currency. This increases the odds on the uptrend continuing,
Volumes can be erratic especially if trading on a particular day is light. The best way to keep track of the price/volume situation is to draw trend lines on both the price and the volume charts. If the trend lines move in the same direction, than you probably have a sustained healthy trend. If the trend lines diverge, say a continuing rise in prices but dropping volumes, it means that buyers are losing interest and you should be preparing to exit the position.