How to use Forex Trading Volume?

Forex volume refers to the total number of transactions or the amount of a currency traded over a specific period. Since forex is a decentralized market, forex volume doesn’t have the same transparency as the equity market.

Still, it is a valuable tool for analyzing market trends, sentiment, and liquidity, providing some insight into the market's state.

How Forex Volume Works?

Unlike centralized exchanges like the stock market, the forex market is decentralized, meaning there isn’t a single source to track the total volume of trades. Forex volume is typically measured in two ways: tick volume and contract volume. Tick volume refers to the number of price changes (ticks) within a specific time frame, whereas contract volume measures the number of units of currency traded.

Since the forex market lacks a central order book, traders rely heavily on tick volume as a proxy for the actual volume of trades. Many forex platforms, such as MetaTrader, use tick volume to approximate market activity, which can be analyzed alongside price movements.

The Relationship Between Volume and Price Movement

Volume and price are interrelated. When volume rises significantly during a price move, it indicates strong momentum behind the trend, either bullish or bearish. On the other hand, when price movement occurs on low volume, this situation might suggest weakness or uncertainty in the trend.

This fact might help traders confirm trends and avoid false breakouts, particularly when using a breakout-oriented trading strategy.

For instance, if USD/SGD trends upwards and volume increases, more participants are entering the market, reinforcing the trend strength. If the volume decreases during a price rise, it could signal that the trend is weakening, and a reversal might be imminent.

Volume Bars and Their Significance

On most trading platforms, volume bars are displayed below the price chart, representing the volume of trades for each candlestick period. Green volume bars typically indicate an increase in buying activity, while red volume bars signify an increase in selling activity.

It is worth paying attention to the color of these bars, especially when the price is at key support and resistance levels.

Using Volume to Identify Trends

One of the primary uses of volume in forex is to confirm the strength of a trend. When a market moves in a certain direction with high volume, it is a strong indicator that the trend will likely continue. For example, if volume continues to rise in an uptrend, it suggests that buyers are in control and pushing prices higher. However, if volume begins to decline while the price is still rising, it may indicate that the trend is losing steam.

On the other hand, when the price moves in a particular direction with decreasing volume, it can be a warning sign that the trend is weakening. This often leads to a consolidation period or even a reversal.

Volume Divergence and Its Implications

When price and volume move in opposite directions, we say a volume divergence exists.

For example, if the price of a currency pair is making higher highs while volume is decreasing, this could indicate that the upward trend is losing momentum, and a bearish reversal may follow.

On the opposite, if the price is making lower lows but volume is increasing, it may suggest that the downtrend is nearing its end, with buyers starting to take control.

Volume and Price Breakouts

Volume plays a crucial role in identifying legitimate breakouts. A breakout is when the price of a currency moves beyond a key support or resistance level. A breakout should be accompanied by a high volume to be considered strong. If a breakout occurs with low volume, there’s a higher chance that it’s a false breakout, meaning the price will soon return to its previous range.

Using Volume to Evaluate Market Sentiment

Volume can gauge market sentiment, giving traders insight into whether the market is dominated by buyers (bulls) or sellers (bears). High-volume periods often reflect heightened emotions, such as fear or greed, and can mark turning points in the market. For instance, during panic selling, volume may spike, suggesting capitulation, when many traders close their positions.

Volume and Sideways Forex Market

During periods of consolidation, the price moves sideways within a range. Low volume during consolidation usually signals indecision or a lack of conviction from traders. However, if volume increases during consolidation, it can signal that a breakout is imminent, either in the direction of the previous trend or in the opposite direction.

Volume and Forex Risk Management

Volume analysis can help traders identify areas of increased risk. For instance, a sudden spike in volume during a price decline might indicate that traders are panic selling, which could lead to further downward pressure.

In contrast, low volume during an uptrend might suggest that the buying power has been exhausted, and for a buyer holding a long position, it might suggest taking a partial profit or putting a stop-loss order below the nearest support level, anticipating a potential reversal.

Volume and Market Liquidity

Liquidity is critical in the forex market, affecting the ease of entering and exiting trades. Volume can give traders an idea of the market’s liquidity. High-volume periods typically correspond to more liquid markets, where traders can execute trades with minimal slippage. Low-volume periods, on the other hand, can result in wider spreads and increased trading costs.

Common Volume Indicators in Forex Trading

Several technical indicators incorporate volume data to help traders identify potential trading opportunities. Popular volume indicators include:

On-Balance Volume (OBV): Measures cumulative buying and selling pressure by adding volume on up days and subtracting it on down days. This indicator works similarly to RSI, showing divergence between price and positive/negative volume movement.

EUR/USD H1 chart with on-balance-volume, Source: TradingView

• Chaikin Money Flow (CMF): It is an oscillator that uses volume and price to gauge the strength of a trend and identify potential reversals. A positive reading indicates buying pressure, while a negative reading indicates selling pressure.

EUR/USD H1 chart with Chaikin money flow, Source: TradingView

 

• Accumulation/Distribution (A/D): Analyzes both price and volume to determine whether a currency is being accumulated or distributed. Works similarly to on-balance volume with traders looking for trend confirmation and divergences to signal a potential trend shift.

EUR/USD H1 chart with Accumulation/Distribution, Source: TradingView

Limitations of Volume Indicators

While volume indicators can provide valuable insights, they also have limitations. Forex volume data is often incomplete, as it only represents the activity on a specific broker or platform. As a result, it may not reflect the true market-wide volume. Additionally, volume indicators are lagging, reflecting past activity rather than predicting future moves. Traders should use them in conjunction with other tools, such as trendlines or moving averages, for a comprehensive analysis.

 

 

Frequently Asked Questions

How do you determine volume in forex trading?

The forex volume is typically determined by the number of tick movements in the market. The greater the number of tick movements, the higher the volume.

Does volume matter in forex?

Despite the decentralized forex market, volume still matters to an extent. It provides traders with more information about the trend's strength or the likelihood of a reversal.