Understanding market activity is one of the most important and often overlooked aspects of becoming a consistently profitable forex trader. Volume indicators forex traders use provide crucial insights into the strength behind price movements, which can enable you to draw the line between the real breakout and weak, unsustainable ones.
In contrast to stock markets, where the real trading volume is captured, forex is a decentralized market, and the tick volume of forex data is the best proxy of actual trading volume. This blog will demonstrate how volume indicators are applied in the forex market, the most useful volume indicators, and how forex market activity can be read better using the volume based analysis.
What Is Volume in Forex Trading?
Volume in conventional markets is the total number of shares or contracts that are traded in a certain time period, and it provides the traders with a direct indication of the amount of the market being involved in and the amount of activity that is going on. True volume data are not centrally registered in the forex market since trades are recorded in thousands of various banks, brokers, and liquidity providers around the world at the same time. It is replaced with tick volume forex data, which is the number of changes or ticks in price that occur over a specified period of time as an indirect measure of trading activity.
Studies have indicated that the volume of tick is closely associated with the volume of actual traded in the forex market, and hence it is a good and convenient replacement for the real volume data. Understanding how to read and interpret volume indicators that forex traders rely on can give you a valuable clue to knowing the real strength or weakness behind any price action.
Why Volume Indicators Matter in Forex
Price action does not necessarily give the whole picture of what is going on on the forex market at a specific time. A price breakout having a high volume is much more dependable and likely to continue as compared to that having low volume and little market participation. Volume indicators forex traders use help to validate that a trend actually has institutional backing to it or that it is a daily fluctuation created by thin and easily liquidatable order flow.
Reading forex market activity through the lens of volume gives you an additional layer of assurance that the vast majority of the traders who only focus on the price-based analysis entirely miss. The analysis of volume can be the second addition to your trading plan: it allows you to avoid trading on incorrect breakouts and have more confidence in the data when the volume indicators are in your favor.
1. On-Balance Volume (OBV)
On-Balance Volume is one of the most widely used volume indicators that forex traders apply to measure the cumulative flow of volume in relation to price direction over time. It functions by making an addition on up days and a deduction on the down days, which forms a running total, which shows whether a currency pair is taking in or giving out volume. When price and OBV are increasing together, it is a good indication that the buying pressure is high and the uphill trend has serious underpinning by active market actors.
When OBV and price are out of sync, such as when a price is in a new high, and the OBV is not, this is an indication that the direction is not being supported, and a reversal could be in the offing. OBV works best on the daily and four-hour charts on which the cumulative volume data is statistically significant and less subject to short-term noise.
2. Volume Oscillator
Volume Oscillator is used to calculate the difference between two moving averages of volume, and it presents the result in the form of a histogram that swings above and below the zero line. The fact that the oscillator is above the zero means that the short-term volume exceeds the long-term volume, and, thus, the fact that the current price movement is well supported by the robust and active forex market activity. Negative value indicates that the volume is decreasing as compared to its long term average, which can imply a decrease in the momentum or may show the trend to become exhausted.
Day traders combine the Volume Oscillator and the price breakouts to ensure that a direction that has left a consolidation zone has the required traffic to continue to the desired direction. The Volume Oscillator spikes at important price levels or pattern breakouts are some of the best indicators that may imply the involvement of institutional traders in the move.
3. Chaikin Money Flow (CMF)
The Chaikin Money Flow indicator combines both price and tick volume forex data to measure the flow of money into and out of a currency pair over a specified lookback period. CMF readings above zero signify that the buying pressure is prevailing, and the money is flowing to the currency pair, hence an upward price bias in the market. A negative reading indicates the selling pressure, which means the money is leaving the pair and therefore a bearish directional bias in the eyes of those traders who wish to sell off the pair.
The intensity of the CMF reading also matters, as any reading higher than 0.25 or lower than -0.25 portrays a very strong and directional money flow, which has more analytical value. The CMF, together with support and resistance levels, can assist the traders in locating high-probability areas, where the heavy money movement coincides with the major technical zones of prices.
4. Tick Volume Bars
Tick volume forex bars are a direct reflection of trading activity in the form of a vertical bar at the bottom of a price chart, where longer bars represent a greater level of tick volume and shorter bars represent a less active trade. Looking at the height of the volume bars against recent averages gives the traders an instant impression of whether forex market activity is below or above the normal levels. One of the most obvious indications that institutional money is actually driving the move is a strong bullish or bearish candle with a volume bar that is considerably higher than average.
On the other hand, when the price candle is big, and the volume bar is very small, then this is an indicator that the action may not be lasting and would turn around at short notice. One of the most viable and readily applicable volume analysis skills in forex trading is learning to read tick volume bars by taking into account the surrounding price action.
5. Accumulation/Distribution Line
Accumulation/Distribution Line is a sophisticated volume indicator that combines price position and tick volume forex data in measuring the time-net accumulation/distribution of a currency pair by the buyers and sellers, respectively. A line that is moving up with the price suggests that it is undergoing a good accumulation and makes one optimistic about the future of the currency pair under analysis.
The falling Accumulation/Distribution Line during an uptrend is a bearish divergence that may indicate the smart money may be quietly distributing the positions in strength before they turn. This indicator is specifically useful to swing traders who would like to know the intentions of the institutional players in the long-term before making the commitment to the trade on a multi-day basis. Accumulation/Distribution Line is most effective on the daily and weekly charts, where the volume data is better reflective of the real institutional forex market activity.
How to Use Volume Indicators Together
Using multiple volume indicators together creates a more complete and reliable picture of forex market activity than relying on any single tool alone.
- One can assume a combination of the tick volume bars to have instant visual confirmation on the breakouts, the trend confirmation, and the divergence signal through the use of the OBV and directional strength of the money flow at specific levels through the CMF.
- Volume analysis alone should never be used to make a trading decision without seeking at least two volume indicators of agreement.
- Analyzing volume is best when it concurs with your price action analysis, support and resistance levels, and overall direction of a trend on a higher timeframe.
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Final Thoughts
Volume indicators that forex traders use are powerful and often underutilized tools that can greatly enhance the quality and reliability of your forex market analysis. More so, an OBV, a Volume Oscillator, Chaikin Money Flow, tick volume bars, or the Accumulation/Distribution Line, each of the tools mentioned is a nice addition to the comprehension of what is actually going on behind the price movements in the market.
Reading tick volume forex data effectively takes practice, but the knowledge that it will give on institutional investment and actual market propulsion is worth the time and effort put into it. Having volume indicators as a part of your analysis structure and a trusted broker working behind your trades, you will be much better prepared to analyze the forex market activity appropriately and make trading decisions with more confidence and cohesion.
