Mastering Volume Analysis: Top Trading Strategies for Success

May 28, 2024

Written by:
John McDowell

Volume, volume, volume. If price and volume were a couple, they’d be like Noah and Allie or Jenny and Forrest, two peas in a pod, or like peas and carrots. They just go well together. And apart, it’s hard to make sense of life, much less charts. Sure, you could try to go it alone, but volume gives a purpose to price that no other indicator can.

If price is the voice of the stock, volume is how loudly it speaks. It lets you know weakness, strength, breadth, and more. Without volume, you might as well be talking over text, and as you know, a lot can be misconstrued through text alone.

Introduction to Volume Analysis

Volume is a metric in stock trading that measures the amount of shares traded within a specified time frame. It is most often represented at the bottom of a trading chart and corresponds to the time frame of the price bars for that given period. For example, a 1-minute chart will show the price open, high, low, and close for one minute. The associated volume shows the aggregate of shares traded during that one-minute period.

Volume can also be expressed as a profile, and we’ll discuss that later in advanced volume techniques.

The importance of volume cannot be overstated when learning technical analysis. As long as the data is valid, it offers the lay trader an opportunity to read the tape, without actually reading the tape or level II. In other words, in the absence of “dark pool” data, volume is the footprint of all the buyers in the tape. 

Ways to Use Volume in Trading

Volume bars are not as confusing or meaningless as they may appear on a chart. They tell a story, just like price does. That story depicts accumulation or distribution, demand or supply. And, often, it can reveal key levels that institutions and market makers are buying and selling — what we like to refer to as support and resistance levels.

For the sake of this article, we’ll hone in on several strategies for analyzing volume:

  • Volume confirmation
  • Volume divergence
  • Significant volume
  • Volume by price
  • Relative volume
  • VWAP Boulevard

Let’s take a look at each of these and how they can help your technical analysis. 

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Volume Analysis Trading Strategies

Volume Confirmation

Volume often confirms the strength of a breakout or breakdown in stock trading. This isn’t a 100% accurate heuristic, but it’s often used to confirm bullish or bearish behavior. Volume confirmation can also confirm support and resistance levels.

Volume confirmation on breakouts occurs after a stock has consolidated for a while. As a stock trends sideways, or chops up and down between resistance levels, it will usually increase in volume at these levels. As you can see from the chart below, the increased volume signature can denote either buying or selling pressure as shares change hands and institutions vie for positions. 

On breakouts, a general rule of thumb is that you want to see increased demand. This is a combination of short-sellers capitulating their positions and breakout buyers jumping into the stock for a big move upward. These “breakout bars” and the volume associated with them are a type of confirmation signal to bulls who are looking for a new trend to form.

Similarly, if a stock breaks below a prior support level, it can spell trouble for bulls as their stops get hit, adding selling pressure to the shorts who are betting on the stock to decline in price. This combination will often result in higher volume around the edges of the trading range, particularly on a breakdown.

Volume Divergence

There is a concept in volume analysis called synchronicity. When things are in sync, you expect them to behave in harmony. However, when things are “out of sync,” it can sometimes forebode trouble. This is where volume divergence comes into play.

Volume divergence can sometimes portend trend reversals. Think of it like effort versus result when combined with price action. For example, if the volume is diminishing at the top of a climactic run, but price is not in sync with the volume, you might be witnessing a distribution event. In other words, a lot of shares are being traded, but the price isn’t going up as much as you would expect given the amount of volume. 

This can go both ways. There is a concept called “ease of movement,” which is a type of divergence as well. If a stock has undergone a period of accumulation with higher volume, it can often move upward in price very quickly and without much effort. 

These are examples of divergences you can see in volume analysis.

In this first example, you see a classic volume divergence during a stage 3 distribution event. Notice the climactic volume, followed by several increased volume days where the price fails to make a new high. This is a perfect example of how volume increases, but price stalls, thereby creating a volume divergence.

In this second example, we see a classic accumulation pattern for weeks. Notice that volume has increased significantly during this phase. Then, as price finally exits the trading range and makes new highs, it doesn’t require as much effort. This is due to the lack of supply left in the amount of shares. Once institutions are locked in, price moves higher more rapidly with less demand — less volume.

Significant Volume and Price Bars

Significant volume and price bars associated with them can define areas of support and resistance no matter where you look at a chart. They can provide areas of support in uptrends, downtrends, and consolidations. This is likely a result of an institutional buyer/seller at these levels. 

For example, in the chart below, you’ll see the highlighted volume and price bars of significance. Notice how this area comes into play later as the stock retreated to those levels but found support there. 

These levels can often come into play more than moving averages and other indicators. Institutions often have a target price where they want to be averaged into a position. If they can achieve this, they need to do it over time, but there will be areas of accumulation that are difficult to avoid — hence the significant days we see on the chart.

Volume by Price

Volume by price, volume at price, or volume profile is a great way of seeing where volume accumulates on a price scale. Instead of using the lower part of a bar chart to show volume, it shows you the price levels at which volume accumulates. 

Why is this significant?

Many technical traders look for these areas with a similar approach to the significant volume we mentioned above. When you display volume at price, you can see pockets of liquidity, supply, and demand and compare it to the price action it is associated with. 

Some would argue you can achieve the same by reading volume and analyzing congestion zones, but it simplifies the process for you. The only part you need to define is your “look back” period. In other words, how many periods do you want to analyze volume, 10 periods, 20, 30, or more? This will determine if the volume is significant recently or for a broader time frame. 

Relative Volume

Relative volume is an important statistic for early morning day traders. Shortened to RVOL, it is a percentage of the current trading volume compared to a historical average for that stock. In other words, if the stock is trading a couple hundred thousand shares in the premarket, but normally only trades a couple hundred thousand shares in a day, you could easily see that the stock is experiencing extra volume for that day. Hence, it will have a high RVOL ratio. 

Many day traders will use this stat when determining intraday momentum, early morning capitulation, and other strategies. 

RVOL, or Relative Volume, is a technical indicator that measures the average volume of a security over a specific period, usually 10 days. It’s calculated by dividing the security's current volume by its 10-day average volume. The ratio of those 10 days would be equal to 1.0.

If a security with an RVOL ratio of 1.0 suddenly increases to 2.0, it has twice the average volume, essentially. Likewise, if a stock's RVOL measures 0.50, it has half the RVOL of the prior 10-day average.

The indicator can be used to identify stocks that are trading above or below their historical averages. This is a nice preset in many day-trading scanners and screeners, which can help make trading decisions.

VWAP Boulevard

VWAP Boulevard is the is an interesting concept popularized by a trading personality on the X platform. For an in-depth look at how it all began and what it is, make sure you take a look at our guide to vwap boulevard

If you're familiar with vwap, the volume-weighted average price, you'll love Vwap Boulevard. This indicator gives you the ability to find the average weight price for significant volume bars. What's amazing about this, is that these levels come into play as support or resistance lines for future price action.

Here we have it drawn on the AMD chart below. Notice that it pegs the top 5 volume bars and finds that the vwap for that day. As you can see, it becomes a level of support and resistance for the ensuing trading range:

This can be used intraday, daily, or using multi-timeframe analysis. It's a great way to see the levels for significant volume candles and predict trading ranges before or as they are forming.

Advanced Volume Indicators

Moving beyond the basic volume bars, several advanced volume indicators may offer a deeper view into buying and selling pressure. Let's take a high-level view of a few of these.

  • Volume Flow Indicator (VFI): The volume flow indicator calculates the imbalance between buying and selling volume. This could be beneficial in identifying shifts in market sentiment and potential turning points by highlighting areas of heavy buying or selling pressure.

  • Volume Price Trend (VPT): This indicator aims to assess the validity of a price trend by combining price and volume data. In simple terms, an uptrend is confirmed if the price rises and the VPT rises. However, if prices fall and the VPT falls, it confirms a downtrend. If there is a divergence between price and VPT, it can portend a trend reversal.

    Here is an example of the VPT underlay on a chart:
  • Volume Candles: Volume candles are another way to train your eyes to see the significance of volume. Volume candles distort the candles in such a way that they become "fattened" when there is high volume.

Using Volume for Risk Management

Strangely enough, volume can be instrumental in managing risk when associated with price structure. One of the best ways to understand this is to study chart patterns and observe what volume does as the structure forms. 

For example, let's look at this chart of NVDA and zoom in on a significant candle with significant volume. Notice how the price is already in an uptrend and accelerating with this significant candle. The volume provides an area of support, allowing us to risk below the lows of that candle.

These areas of increased volume should give us the confidence to take trades with a definable risk area. It is natural for a stock to digest a big move by pulling back and testing the supply in that area. If it holds, we can take a position and risk the lows of the pullback.

Volume Analysis Summary

By now you should have a good grip on why volume analysis is important to technical analysis. Volume can be displayed in a myriad of ways, but it tells the same story regardless of where you represent it on the chart. It's the voice behind price movements. It is the footprint of the market participants.

With enough time and observation of charts, you'll have no problem reading the tape through the chart. However, we recommend doing this in a safe environment like a simulator. This gives you a "real-time" experience, but without the risk of losing real money while you learn. 

Here at Tradingsim, we offer the most realistic simulator for crypto, stocks, and futures. You can access historical market charts and replay that data 24/7.

Take advantage of our 7-day free trial. Join us in the sim, and here's to good fills!

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Tags: Volume Indicators, Day Trading

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