Volume Price Action Analysis

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Volume Price Action Analysis in Trading

In this article, I will discuss Volume Price Action Analysis in Trading. Please read our previous article discussing 3 Rules for Volume Analysis in Trading. At the end of this article, you will understand the following. 

1. Understanding Market Structure through Volume Swing Analysis
2. Strength and weakness of swing through volume price action analysis
3. How to analyze volume in trading

Understanding Market Structure Through Volume Analysis

In the first part, we have studied 3 laws of volume analysis. These are

1. THE LAW OF SUPPLY AND DEMAND
2. THE LAW OF CAUSE AND EFFECT
3. THE LAW OF EFFORT VS RESULT

Based on these laws, we know the big picture analysis is market structure analysis using volume. Because the final decision-making depends on the market structure

Market Structure

It is similar to learning to read a new alphabet- once you understand the characters, you can read the words, and once you know the words, you can read the story. So, the market structure consists of short-term swings.

• The market moves in an up-downswing, what we call a market swing. In a healthy bull trend, the upswing generally exceeds the downswing in length, and the reverse is true for the bear market.
• Hence, by observing market swing, we can glimpse into the market structure and get clues on whether the market will move up or down.
• So basically, prices move in an uptrend or downtrend

1. In a healthy bull, the trend Price Makes a Higher High (HH) and Higher Low (HL)
2. In a healthy bear, the trend Price Makes a Lower High (LH) and Lower Low (LL)

Let’s understand the rally (opposite of decline)

What happens during the rally?

During the rally, what has been going on? Two things

1. First, the buying of stock by those who are covering their previous short sales(after knowing that they are in the wrong direction) and
2. Second, actual new buying by those who expect the advance to continue

What happens after the rally?

1. If the rally is due to more short covers than long buyers, it will likely decline in the future.
2. If the rally is due to actual new buying, the trend is likely to continue

How can I tell which type of rally is? (Short covering or long buying)

Watch the volume and momentum of price changes

• If PRICE rises with momentum and VOLUME rises, the market is STRONGLY BULLISH. The move is by long buyers. HARMONEY
• If the PRICE is rising, but VOLUME is falling, and momentum is also falling, the market is WEAKLY BULLISH. The move is by short covering. DIVERGENCE

Why is PRICE rising and VOLUME rising in the rally?

For price to overcome selling pressure created by

1. Profit-taking selling order
2. New selling order at the market top

What indicates HARMONEY & DIVERGENCE?

It should be noted that the price movement will be indirectly proportional to the amount of effort expended.

• If the effort is in harmony with the result, it shows the movement’s strength and suggests its continuation. If the effort is in divergence with the result, it is a sign of weakness of the movement and suggests a reversal.
• The result tends to be in direct proportion to harmony or divergence. If divergence is suggested, a smaller divergence tends to generate a smaller result, and a larger divergence tends to generate a larger result. On the other hand, If harmony is suggested, a greater effort will cause a movement of long duration. In contrast, a slight effort will be reflected in a movement of shorter duration.

General Rules for Interpreting Volume to determine the health of a trend

1. If PRICE rises and VOLUME rises, the market is STRONGLY BULLISHED.

Volume helps us to determine the health of a trend. An uptrend is strong and healthy if volume increases as the price moves with the trend and decreases when the price goes counter-trend (correction periods or ‘pullbacks’).

2. If the price rises but VOLUME falls, the market is WEAKLY BULLISH. Uptrend weakening

When prices rise and volume decreases, it tells that a trend is unlikely to continue. Price may still attempt to rise at a lesser pace, and once sellers take control (which is usually signified by an increase in volume on a down bar or candle), prices will fall.

1. If PRICE is falling, VOLUME is rising, the market is STRONGLY BEARISH.
2. If PRICE and VOLUME are falling, the market is WEAKLY BEARISH. Downtrend weakening

Understanding Market Structure through Volume Swing Analysis

The movements of the price do not develop in periods of time of equal duration, but they do it in the swing of different sizes. For this reason, we have to study the relationship between the upward and downward swings

The swing of the market furnishes a clear insight into changes in supply and demand. By learning to judge all sizes (up and downswings) of market swings, you will gradually learn to spot the time when a rally and a reaction have stopped and are about to reverse. These are the turning points.

Here, we have to find out.

1. Strength and weakness of swing through volume analysis or find out harmony and divergence
2. volume analysis at the key level for decision-making

Strength and weakness of swing through volume analysis

There are two methods to find out strengths and weaknesses in swing through volume analysis

Compare the volume of the current price swing with the volume of the previous price swing in the same direction.

This means comparing the current impulse swing vs. the previous impulse swing. What is it telling? Volume increasing or decreasing or the same volume. Let’s understand the divergence

• Compare the volume of UP-swings (A) and upswing (B). Note the decreased VOLUME of the swing (B), indicating a reduction in bullish VOLUME. Weakness is appearing on the bullish side.
• When prices are rising, and volume is decreasing, it tells that the trend is unlikely to continue. Price may still attempt to rise at a slower pace, and once sellers take control (which is usually signified by an increase in volume on a down bar or candle), prices will fall.
• The move is by short-covering RALLY.
• A low-volume upswing as the market attempts to rally above these old tops is telling you clearly that the market is not going anywhere.
• High volume up bars in the same areas is certainly indicating that there is supply in the market. If the market makers and specialists are still bullish, they will have to absorb any supply that appears, and this will allow prices to continue up.

Let’s understand harmony.

• When comparing the current upswing B volume with the previous upswing A volume. Note the increasing VOLUME on A swing, indicating an increase in BULLISH STRENGTH. BULLISH price swings are showing signs of strength
• RISING PRICE IS ACCOMPANIED BY RISING VOLUME. It means the market is STRONGLY BULLISH. Price will continue the trend.
• High volume up bars in the same areas is certainly indicating that there is supply in the market. If the market makers and specialists are still bullish, they will have to absorb any supply that appears, and this will allow prices to continue up.

Compare the volume of the current price swing with the volume of the previous price swing in the opposite direction.

This means comparing impulse volume vs. retrace (pullback) volume. In general, a healthy trend has increasing volume on impulse move and decreasing retrace volume. Let’s understand harmony.

• When comparing the current downswing B volume with the previous upswing A volume. it shows volume decreasing. Strength is now clearly on the bullish side.
• Price movement is expected in the direction of strength. When prices are falling, and volume is decreasing, it tells traders that the trend is unlikely to continue in the down direction. Price may still attempt to fall slower, and once buyers take control (which is usually signified by an increase in volume on an up bar or candle), prices will increase.

Let’s understand the divergence.

When comparing the current upswing B volume with the previous upswing A volume, IT SHOWS PRICE is falling, and VOLUME is rising, meaning bearish PRESSURE overcoming bullish PRESSURE. TREND CONTINUES IN A DOWN DIRECTION.

Volume Price Action Analysis in Trading Summary:

Volume Price Action Analysis is a method used in technical analysis to understand the behavior of the market and make trading decisions based on the price movements and the volume of trades. The core idea is that volume is the fuel behind the price movements; more significant price changes accompanied by high volume are seen as more meaningful and are more likely to signal a trend than price changes with low volume. Here’s an overview of how you can perform Volume Price Action Analysis:

Understanding Price Action:

First, let’s understand what price action involves:

• Trend Identification: Using price charts, you identify the current trend—upward, downward, or sideways (range-bound).
• Support and Resistance: These are price levels where the price tends to find a floor (support) or a ceiling (resistance).
• Price Patterns: Patterns like head and shoulders, triangles, flags, and pennants may indicate continuation or reversal.
• Candlestick Patterns: Specific patterns can indicate bullish or bearish sentiment.
• Breakouts/Breakdowns: When the price moves beyond a defined support or resistance level with increased volume, it can signal the beginning of a new trend.

Analyzing Volume:

Volume is critical for confirming price action:

• Trend Confirmation: Volume should increase in the direction of the trend. For an uptrend, increasing volume on up days and decreasing volume on down days are positive signs.
• Volume Oscillators: Indicators like the On-Balance-Volume (OBV) or the Volume Price Trend (VPT) indicator can help analyze the volume flow over time.
• Volume and Breakouts: A breakout or breakdown on high volume is more likely to be sustainable. Low-volume breakouts are often suspect.
• Climax Volume: Extremely high volume can signal a climax of price movement, after which there may be a reversal.

Combining Price Action and Volume:

When combining these two, here’s what you generally look for:

• Confirmation: Volume should confirm price action. If prices are moving up and volume is increasing, it is generally considered a bullish sign.
• Divergence: If the price is reaching new highs but volume is declining, it could indicate that the trend is running out of steam—a potential bearish divergence.
• Volume Clusters: These can often form at significant support or resistance levels, indicating a potential turning point.
• Volume on Pullbacks: In a healthy trend, pullbacks should occur on a lighter volume, suggesting that the trend is still intact.

Practical Steps for Volume Price Action Analysis:

Here’s how you might apply this analysis practically:

• Chart Set-Up: Use candlestick charts for price action and a volume histogram below the price chart.
• Identify Key Levels: Mark out historical support and resistance levels.
• Observe the Trend: Note whether the market is trending or range-bound.
• Watch for Patterns: Look for price and volume patterns that suggest a continuation or reversal.
• Seek Confirmation: Use volume to confirm the strength of price movements.
• Take Note of Anomalies: If there’s a divergence between price and volume, investigate further before making a trade.
• Entry and Exit Points: Use changes in volume at key price levels to identify potential entry and exit points.

Important Considerations:

• Timeframe: The analysis can differ based on whether you look at intraday, daily, weekly, or monthly charts.
• Market Conditions: Volume price action may need to be interpreted differently in bull markets, bear markets, or periods of high volatility.
• Volume Data Quality: In some markets, like Forex, true volume data isn’t available, and traders use tick volume as a proxy.

Tools and Indicators:

Traders may use various tools and indicators to assist with Volume Price Action Analysis:

• Volume Bars: Color-coded to show whether the volume was associated with rising or falling prices.
• VWAP (Volume Weighted Average Price): Gives an average price a security has traded at throughout the day, based on both volume and price.
• Accumulation/Distribution Line: Look where the price closed within the range and volume to determine how much volume is associated with accumulation or distribution.
• Volume Oscillators: Can help identify trends or warn of reversals when they diverge from the price action.

So, Volume Price Action Analysis can effectively predict future price movements. However, it’s essential to remember that no analysis method can guarantee results, and it should be used in conjunction with other forms of analysis and sound risk management practices.

In the next article, I will discuss Volume Spread Analysis in Trading. In this article, I try to explain the Volume Price Action Analysis in Trading. I hope you enjoy this Volume Price Action Analysis in Trading article. Please join my Telegram Channel, YouTube Channel, and Facebook Group to learn more and clear your doubts.