By Taro Hideyoshi
I wrote about trading volume and how to use it in trading before. Here, we will extend to the application of volume as an indicator in trading. Let’s see how we apply volume as a technical indicator.
Volume plays an important role as an indicator traders use to indicate price direction. Interpretation of volume signals will be one of the handiest tools in your trading toolbox.
Volume is like a form of energy, securities respond to energy. Traders’ energies translate into volume which is the number of shares traded in a specific period of time.
Typically, you can spot representation of trading volume and spikes that run along the bottom of charts we are observing. If you are looking at a daily candlestick chart, a spike below represents the total number of shares trading during that day.
As I mentioned in the beginning, volume is an important indicator, the following are general approaches to read trading signals from the volume.
First, look for high volume on price breakout. When price break its resistance and go up (or break its support and go down). As the price continues their direction, you expect for strong volume. When the price tops off and pullback, you have to make sure that the pullback volume is relatively low. If the pullback volume is strong, it is better to take profit.
Second, scan charts to find the securities that are building their bases by locating the security that increasing in volume while its price continues to trade in the same tight and price range as before. This pattern indicates a high possibility to that institutional investors are quietly accumulating. You have options to wait for the price breaks out or enter a trade while securities are still in the base. If you choose the second, you have to set your stop loss extremely tight to minimize risk.
The third is to use volume and chart pattern together. For example, after 2-3 days up, if today’s price makes a new recent high but the candlesticks form as a doji, star, or other reversal patterns. It’s good time to take profits.
Finally, if climatic volume designated by a huge volume spikes near the end of extended trend, it often indicates that the trend might soon slow or end. Conversely, just because a climatic volume signals a trend reversal, do not take this as a signal to start bottom fishing. The patterns sometimes take a few days or occasionally, misfire.
About the Author
Taro is an experience trader who trades in stocks, futures, forex. He strongly focuses on technical analysis, trading systems and money management.
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