How You Should Really Use Volume In The Forex Market

In today’s article I want to spend a little bit of time explaining how we can use volume to get a better understanding of what’s going on in the market.

Many traders dismiss volume as not being reliable and to some extent this belief is true.

The volume we see on our charts is not the true actual volume, it’s the tick volume from the brokers platform.

Tick volume is where 1 tick equals 1 trade, this means if you see a large volume spike in the market its telling you that a lot of traders either placed trades during the that time period or they closed trades.

The true amount of volume cannot be known in the forex market because of how many different exchanges there are all over the world in which trading takes place on, when people realize this they tend to shy away from understanding volume and the information it reveals, which is unfortunate because knowing what the volume readings mean can aid you greatly in your trading and understanding of the market.

 

The Link Between Volume And Banks

 

Knowing when lots and lots traders have placed trades can help us in understanding what the large institution’s in the market are currently doing.

For a bank or hedge fund to take some kind of action in the market whether it be place a trade or close a trade they need lots and lots of traders doing the opposite to what they want to do.

For example if HSBC wanted to buy 3 million Euros they need lots of other traders to be selling Euros, the sell trades of the traders selling must at least total 3 million otherwise HSBC will not be able place their entire buy trade into the market.

If we look at this image you’ll notice some of the candlesticks have incredibly high volume (I’ve marked these candles with an arrow)

The high volume means lots traders did something during the creation of this candle, knowing what they did and more importantly knowing what the institutions did during this time require us to understand how traders make decisions.

In one article on this site I talk about reactive traders, traders who will make snap decisions about placing buy or sell traders without any kind of strategy or method so to speak. It turns out that most of the traders trading forex fall into this category.

I know this by looking at the volume.

Most of candles which have high volume readings are the same kind of candles these reactive traders will trade.

When they see large candles like this they will all place buy trades thinking that the market is going to continue higher.

A candle like this however will make them place sell trades because they think the market is going to keep moving lower.

Knowing this information can help us in identifying what bank traders are currently doing.

I’ve annotated this chart with descriptions of what the banks are most likely doing during these high volume candles.

It’s easy to see how having a simple understanding of volume allows to read the market much better, someone with no knowledge of how the banks trade would not of been able to recognize what’s taking place during times when there’s high volume.

 

Volume During News Events

 

If you watch the markets when important news get released then you might have noticed there tends to be very high volume on the candlestick the news get released on.

This is strange, as its commonly accepted that professional traders in banks and hedge funds do not trade during news times.

The reason why they don’t place traders during news events is simple.

Nobody knows whats going to happen!

Although professional traders have access to information we don’t, it doesn’t mean to say they already know what’s going to happen before it happens. News events are not only some of the most difficult events to predict in the market but also some of the most chaotic, if you’ve ever watched the market when big news events get released you’ll see the price tends to jump around a lot, this is due to everyone trying to work out what the news release means for direction in the market.

When news events do get released, especially during the big releases like Non Farm Payrolls and Interest Rate Decision’s, its highly dangerous for professional traders to place trades. The chaotic nature of the way price moves during these times can easily take them by surprise and make them lose money, this is why they will wait until after the news has been released to start entering their trading positions.

So if we know professional traders don’t trade during the times when news gets released then where does all the volume come from ?

Basically it comes from two sources:

 

Source One

 

At the beginning, when the news first gets released and the market is trying to establish a direction, most of the volume will come from the traders who had trades placed in the opposite direction in the market before the news came out.

All the traders in long positions inside the red box I’ve drawn above are now losing money.

The huge bearish candle you can see on the image forces them to close their trades at a loss either by hitting the stop-loss they might have placed or, in the case of somebody who wasn’t using a stop, by putting them at such a large loss that they just close the trade out of pure fear of losing any more money.

 

Source Two

 

The second bout of volume comes from our good friend the reactive trader.

Around 15-20 minutes after the news has been released the market will have established a clear direction, in most cases by this point the market will be either be moving up or down quite strongly with large candles, this will entice the reactive traders to place trades in the direction they see the market moving.

Looking at the image above you can see I’ve marked 4 arrows, these arrows signify when and where reactive traders will start placing trades, by the time the market has reached this point it’s readily obvious to everyone the market is moving lower, meaning their going to place sell trades to try to capture an extension of the down move.

Also if you look at the volume, you can see after the big spike on the large bearish candle it begins to steadily decrease, all of this volume is coming from the reactive traders and to some extent the trend traders who are selling just because they see the market going down.

 

Summary

 

The main point of today’s article was to give you the real understanding of how to read volume in the market, not the usual volume studies which many traders already have knowledge of such as volume spread analysis for example, but instead a method of linking the volume on your charts to the actions of the participants in the market, in this case the banks and hedge funds.

Because at the end of day these are the people who control the market, and knowing what their up to can provide valuable insight as to which way the market may go in the future.