May 15, 2022
How to Use Volume for Day Trading?
As a day trader, volume is an important indicator that you can use to know when to get in or out of a trade quickly. Volume relates to the number of shares a particular stock or futures contract is traded at any given period. With it, day traders can understand the liquidity level of assets. Traders who use volume for day trading do relatively better than those who ignore it.
Another reason using volume for day trading gives you an advantage is because it shows you the weight of price movement. For instance, if a stock moves from $20 to $25 on low volume, the strength of the price action is not strong. Similarly, if the stock makes this price action on a high volume, it means the demand is high. In other words, if there is a strong volume indication, it means that the price may continue to rise.
This same analogy above can also be said about volume when there is selling pressure. Understanding volume in trading gives you an edge, even though it is quite technical to wrap your head around. An easy way to understand volume in trading is to understand that the two main concepts behind volume analysis are selling and buying volume.
With this in mind, in this article, we will try to understand what trading volume is all about and how to use it for day trading. We will also be talking about some of the best indicators you can use to determine trading volume. And towards the end of the article, we will talk about some strategies you can use to improve trading volume results.
What is Trading Volume?
A trading volume represents a record of all trades for a stock during a specified period. This can be anything from 1-minute charts to monthly charts and everything in-between. Several trading platforms print volume bars in either red or green. Usually, the green bar indicates when the stock closes up in price for a given period, whereas the red bar indicates the stock closes lower in the price for a given period.
While this color coding makes things seem simpler, it does not mean that there was more up or down the volume for the period. Rather it simply represents how the stock is closed for a given period. Divide the total trading volume by the period to calculate the average trading volume.
Several day traders use the trading volume to determine whether large stock orders could affect the current market price. If the trading volume is low on average, the chances are that a large buy or sell will impact the market, causing unfavorable price fluctuation. As a rule of thumb, the higher the trading volume of a stock, the higher its liquidity.
It is important to note that trading volume tends to be higher near the market’s closing and opening times and on Mondays and Fridays. Similarly, trading volume tends to be lower at lunchtime and before a holiday.
Basic Indicators of Trading Volume
Volume indicators, otherwise known as volume filters, help traders draw a line when deciding if a stock fits the criteria they want to trade. They have helped several traders better understand what is happening in the market. Below are some of the most popular volume indicators.
Common Volume Indicators
As a trader, there are three main common volume indicators you ought to know. They are discussed below:
On Balance Volume (OBV) Indicator
The On Balance Volume indicator is a technical analysis indicator that traders use to relate changes in a stock’s price with its volume flow. In his 1963 book “Granville’s New Key to Stock Market Profits, Joseph Granville first created the OBV indicator.” In his book, he proposed the theory that changes in volume measurably precede price movements.
In other words, OBV shows whether there is an inflow or outflow of volume. OBV indicator uses a cumulative total of positive and negative trading volume to predict the direction of price. It is essentially a volume-based momentum oscillator, which changes direction before the price. OBV can be used as a breadth indicator if you are index trading.
The On Balance Volume indicator is calculated by measuring the selling and buying pressure as a cumulative indicator and subtracting down and adding up days in a session. You can use this indicator to identify trends in the market. You can also use it to predict price direction and identify buying and selling prices.
Chaikin Money Flow (CMF)
This indicator is used to discover an emerging trend in stocks. Created by Marc Chaikin, the CMF is used to examine the selling and buying pressure over a set period. The CMF indicator is displayed as a red or green oscillator around a 0-line. In other words, values on the CMF oscillator can range from 1 to -1 depending on their location compared to the zero line.
When a stock is above the oscillator, it is doing well. Similarly, when the CMF is positive, it indicates an influx of buying pressure, which means demands are high and buyers are willing to pay a higher price. Stocks in the zero line cross into the lower half indicate lower demand.
The CMF indicator depends on the stock’s price movement for a specified period. The price point where a stock closes is essential to calculating the CMF. So, we can say the CMF indicator lags behind the market by a day. Hence, studying the CMF value over time is important to sniff out trends.
Stephen Klinger developed the Klinger Oscillator indicator. He postulates that traders can use this indicator to know that a stock will remain sensitive to detect short-term fluctuation. The Klinger oscillator compares the volume flow with the stock’s price movements and then converts the result to an oscillator. With the Klinger oscillator, traders can know the difference between two moving averages based on more than price.
The Klinger Oscillator notifies traders of a potential price reversal through divergence. Traders optimize this indicator by utilizing tools like moving averages and trendlines to confirm trade signals. Traders can also use this oscillator in conjunction with chart patterns such as triangles or price channels to confirm breakdown or breakout.
Although the Klinger oscillator is a bit complex to calculate, its calculation is based on the idea of force volume, trend, and temp. But it is also important to note that divergence and crossovers, the two main functions of the oscillator, are sometimes prone to false signals. Divergence may occur too early, making the trader miss out on a large chunk of the trend. Likewise, the signal line crossover is so frequent that it is hard to filter out which one is worth trading and which ones aren’t.
Other Volume Indicators
- Ease of Movement
- Negative Volume Index
- Money Flow Index (MFI)
- Volume-Weighted Average Price (VWAP)
- Volume-Weighted Moving Average (VWMA)
- Volume Relative Straight Indicator (VRSI)
Understanding the Concept of Volume Analysis
As a day trader, using the volume analysis technique will help you discover the relationship between volume and price. By understanding the concept of volume analysis, you will be able to trade better. To ensure you are trading optimally, you need to wrap your head around some key concepts of volume analysis first. Below are some of the key concepts of volume analysis every day trader needs to understand.
As the name suggests, buying volume is the number of stocks associated with buying trades. Understanding the concept of buying volume is somehow technical, as traders get confused about phrases like “the sellers are in control,” “it is a heavy buy-volume day,” and “buying volume is outstripping selling volume.” But things become pretty straightforward when you realize each transaction must have a buyer and a seller. To buy a stock, a seller must sell to you, and for you to sell, a buyer must buy from you.
An easy way to distinguish buying volume is to look out for the bid price. The bid price is the highest price someone will pay for a stock. As traders buy stocks, the price fluctuates, and the price gets pushed higher, meaning buyers are in control. Buy volumes usually occur at the offer prices, and it represents the lowest advertised price at which sellers buy a stock. When someone buys a stock at its current offer price, it means that someone desires the stock, which is included in the buy volume metric.
Like buying volume, the selling volume, as its name suggests, is the number of stocks associated with selling trades. Selling volume also involves buyers and sellers, but the sellers have more control when the price gets pushed lower. An easy way to identify selling volume is to look out for the asking price. The asking price is the lowest price someone is willing to sell a stock. If a seller wants to sell a stock at the asking price, the seller does not desire the stock.
Selling volume typically shows along the bottom of the stock price chart, depicting trading volume in vertical bars. The bars show how many shares changed hands over a set period. Take, for example, if a trader bids to buy 200 shares for $5.01 and a different trader is bidding to buy 200 shares for $5.02. If another trader sells the 200 shares to the second trader at $5.02, that bid will disappear, meaning the new bid will reduce the price to $5.01. In this analogy, the selling volume at the bid lowered the price.
Relative volume, otherwise known as RVOL, is an indicator that tells a trader how current trading volume is compared to past trading volume over a set time. You can think of relative volume as a radar for how in-play stock is. In day trading, the higher the relative volume, the more in play because more traders are watching and trading it. As a trader, you want to look out for stocks with high volumes, highly liquid, and those with the tendency to trade better than stocks with low relative volume.
You can use relative volume to get in and out of a position quickly, whether with a small or large position. Relative volume helps with this, as when stocks get overbought or oversold, you get a spike in relative volume, which shows sellers and buyers are fighting over an important resistance level and will likely reverse. Relative volume is often displayed as a ratio. So, if, for example, the relative volume of a stock is 5.7, it is trading at 5.7 times its normal volume for that set period.
Another thing to pay attention to as a day trader trying to understand the concept of volume analysis is days with higher than usual volume. Days with higher than usual volume tend to have large price movement and volatility, either down or up. If most of the volume occurs at the bid price, then it is likely that its price will move lower. If the price moves lower, the increased volume indicates that sellers are motivated to remove the stock.
If the majority of the volume takes place at the asking price, then the stock price will go higher due to demand and price availability. The increased volume indicates that buyers believe the stock is moving and desire to buy the stock. Ideally, an active trader or news release that has developed euphoria about a stock’s potential can influence volume trading.
Analyzing Stock Price Movements
Although it is unnecessary, you can easily analyze stock price movements by monitoring the stock trading volume. As a trader, you may find the following description and guidelines helpful for analyzing and understanding volume.
Firstly, an increasing volume shows the conviction of sellers and buyers in either pushing the price down or up, respectively. For instance, buyers are eager to buy if the volume increases as the price moves higher and the stock trend heads up. Such a trend typically happens with larger moves to the upside.
Secondly, a trend can keep on declining volumes for a long time. However, a typical decline in volume as the price trends suggest that the trend is weakening. For instance, if volume steadily declines but the trend heads up, fewer people seek to buy and keep pushing the price up.
Ideally, the price movement should be smaller than the volume in the trending direction. The volume should also be lower when moving against the trend; this is called a pullback. A strong pullback shows strong movement in the trend direction, while a weak pullback makes the trend more likely to continue. To know if a trend is weakening or susceptible to a reversal, look out for sharp price movements and a high volume against the trend.
When volume trends are higher than normal, an extreme volume spike occurs about five to ten times more than the average volume. And for that period, it could indicate the end of a trend. When such a situation occurs, it can be termed an exhaustion move, which is when enough shares change hands that no one remains to keep pushing the price in the trend direction. Such a situation is highly susceptible to reverse quickly.
Basic Guidelines for Using Volume Trends to Improve Results
There are numerous advantages of using volume trends for day trading. If you are not yet using volume trends to improve your trading result, you are seriously missing out.
To make life easier, we came up with this section to help day traders use volume to confirm chat patterns, reversal trades, breakouts, and trends. Let’s explore more.
Confirm Trend Strength
If you are going to use volume trends for day trading, you want to ensure you can confirm the trend direction. To confirm the trend direction, look out for an increased volume in the direction of the trend and decreased volume levels when the currency pair is correcting in the opposite direction of the trend.
For an uptrend, there ought to be a decreased volume when the price moves down and an increased volume when the price moves up. Similarly, to confirm the trend strength for a downtrend, there needs to be a decreased volume when the price moves up and an increased volume when the price moves down.
Identify Trend Weakness
Apart from confirming a trend strength, another way to use volume for day trading is to identify trend weaknesses. Using volume to identify trend weakness is essential if the price reaches new levels of extremes, lower lows, or higher highs. In contrast, the volume is not supporting or confirming those new price levels. In such cases, this could be the first warning signal that the trend is weakening or ending.
To better understand how to identify trend weaknesses, you need to know how to interpret divergence. The main benefit of using divergence analysis is that it is not lagging. You can capture trading opportunities that you may not have noticed before by paying attention to instances of a strong divergence. If you are going to use divergence to determine trend weakness, there are five golden trading rules you should note:
- Do not chase divergence if the price action played out
- Divergence can only display up to four different price scenarios
- For bullish divergence, the swing-low prices represent an indicator’s low point
- For bearish divergence, the swing-high prices represent an indicator’s high point
- The angle or the slope of the line connecting the lows and highs suggests how strong the divergence is
Volume measurements during consolidation are typically low. But if upon the break of the consolidation pattern, the volume picks up, then the volume confirms a higher chance of a sustainable breakout. If you want to understand breakout trading or confirmation, there are two main concepts of breakout you should know: support and resistance breakouts and swing high and swing low breakouts.
Attempting to enter the market when the price moves outside a defined price range (resistance or support), you are breakout trading. Note that a genuine breakout will be accompanied by increased volume. Similarly, the candle closes well above the support resistance level in a genuine breakout trade. The same rule of resistance and support breakout trading applies to swing high and swing low breakout, but with an additional filter.
Another way to use volume for day trading is through accumulation and distribution. Accumulation is a phase when buyers are controlling the market, whereas distribution is a phase when sellers are in control of the market. Accumulation is a phase that occurs when the volume is increased when the market is correcting in a downtrend. In comparison, the distribution phase occurs when the volume is increased when the market is correcting in an uptrend.
The accumulation phase typically means more buyers are coming into the marketing, and a reversal could occur. The distribution phase typically means that sellers are controlling the market. You can identify an accumulation phase when the volume increases compared to the day before, but its closing price is high, and its price hardly moves down. Whereas you can identify a distribution phase when the volume increases compared to the day before, its closing price is lower, and the price hardly moves up.
In summary, volume is an important indicator that everyday traders should know how to use. Although it is somewhat complex, any day trader, especially beginners, can take advantage of its benefits to get better results.
Rising price and volume often mean buyers are interested in the stock, and it is very liquid and easier to buy and sell. It is best to look for stocks with high volume if you are just getting started with using volume to trade. Also, if you will use volume for day trading, learn to measure it in multiple ways, and you will be good to go.
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