Huzefa Hamid, contributor to DailyForex.com, explains how to make forex trading decisions based on volume and dispels the common misconception that the forex markets don’t report volume.
For a currency to be traded and for its price to move from one level to another, volume is required. Or put another way, volume is the gas in the tank of the trading machine. However, volume has often been overlooked in the study of forex charts. The focus has been more on price action alone.
Why Is Volume Important to Understand?
Volume is required to move a market, but it’s a particular type of volume that really matters: institutional money, or “smart money,” which is large amounts of money being traded in a similar way, thus affecting the market greatly.
Only volume shows when price is being affected by this type of activity. Knowing how institutional money operates, we are able to track those traders and trade along with them, so that we’re swimming along with the proverbial sharks rather than being their next meal.
Is Forex Volume Reliable?
There is a common misconception that volume cannot be used reliably in forex trading for two reasons: first, there is no central exchange, and therefore, no official volume data. Second, when you’re looking at volume data on your forex platform, you’re actually seeing “tick volume,” and not actual volume traded, such as the volume with a stock chart.
“Tick volume” measures the number of times the price ticks up and down. This is an excellent indicator of the strength of activity in any given bar. But also, the correlation between tick volume and actual volume traded is incredibly high.
In 2011, Caspar Marney, head of Marney Capital and ex-UBS and HSBC trader, conducted an analysis of actual volume and tick volume in forex. He used data from eSignal, EBS, and Hotspot. For the pairs he studied, he calculated the correlation between tick volume and actual volume is over 90%.
So the question is, how do we go about tying in volume with price action?
The study of volume with price started in the early 1900s with a trader by the name of Richard Wyckoff. His research, then known as Wyckoff Analysis, developed into what is known today as Volume Spread Analysis (or “VSA” for short).
Not all VSA traders or techniques are the same. Some are incredibly software driven and complex, whereas I like to keep it simple.
This simpler approach yields results. Experientially speaking, a success rate of 75% and more is not uncommon with very few consecutive losses.
A simpler approach is reflected in the charts. We have price candles, volume bars, and…that’s it! We use the 50% and 61.8% Fibonacci lines and simple support/resistance to help pin entries, but nothing more.
To summarize:
- Institutional money, or “smart money,” is necessary to move a market and is revealed in the volume bars
- Forex tick volume can be read as an accurate indicator of institutional (smart money) strength
- VSA, when it’s kept simple, can be applied (and taught) more easily with win rates of 75% and more
By Huzefa Hamid, Contributor, DailyForex.com
