Volume indicators in forex trading provide insights into market sentiment, momentum, and potential trend reversals. By analyzing volume data, traders can make more informed decisions about entering or exiting trades.

Volume in the forex market is a valuable tool for predicting future trends. Volume indicators help identify whether a currency pair is experiencing high or low trading activity, providing traders with signals about market continuation or reversal.

What are Volume Indicators?

Volume indicators are technical analysis tools that measure the buying and selling pressure on a currency pair, revealing which side controls the price movement.

Volume is calculated as the total number of traded lots or changes in a currency pair’s price within a specific timeframe.

These indicators allow traders to determine supply and demand, the relationship between price and volume dynamics, liquid support/resistance levels, and more favorable price reversal points.

Interpreting Volume Indicators

• High Volume: Indicates strong buying pressure, suggesting high demand for the currency pair. Traders should consider buying or entering a long position.
• Low Volume: Indicates strong selling pressure, suggesting high supply for the currency pair. Traders should consider selling or exiting a trade.
• Increasing Volume: When a currency pair is trending upward or downward with increasing volume, it signals a continuation of the trend.
• Decreasing Volume: If a market trend is accompanied by falling volume, it may indicate a potential reversal due to weak momentum.

Top 7 Common Volume Indicators

1. On-Balance Volume (OBV)
2. Accumulation/Distribution Indicator
3. Money Flow Index (MFI)
4. Volume Weighted Average Price (VWAP)
5. Volume Spread Analysis (VSA)
6. Chaikin Oscillator
7. Volume Relative Strength Index (RSI)

On-Balance Volume (OBV) Indicator

The On-Balance Volume (OBV) indicator was first introduced by Joseph Granville in his 1963 book, “New Key to Stock Market Profits.”

He emphasized trading volume as the primary driving force behind market movements, advising traders and investors to focus on volume before entering trades.

Granville believed that changes in the OBV indicator often precede price fluctuations on the chart. He proposed that significant price movements are preceded by periods of high volume with minimal price changes. This phenomenon occurs because major players accumulate buy orders while smaller traders sell off the asset.

OBV measures the intensity of cash flow in an asset. If a new candle closes higher than the previous one, add the candle’s volume to the cumulative total. If the next candle closes lower than the current one, subtract the volume from the total.

The accumulated total is displayed as a positive or negative value on a curve chart

Money Flow Index (MFI)

John Welles Wilder introduced the MFI indicator in his 1978 book, “New Concepts in Technical Trading Systems.” This indicator helps traders track the flow of funds into or out of an asset over a specific period.

MFI values range from 0 to 100. Traders use MFI to gauge buying and selling pressure exerted by bulls and bears on the price. MFI helps identify potential reversal points by identifying oversold and overbought conditions in the market.

MFI identifies discrepancies between volume and price, often signaling a potential trend reversal. Professional traders typically use MFI on hourly (H1) and higher timeframes.

However, it is essential to avoid false breakouts. In order to avoid false breakouts while using the MFI, consider the following:

• Enter buy trades after the price breaks out of the oversold zone upward and MFI values start to rise, indicating positive cash flow.
• Open short trades when the price breaks out of the overbought zone downward, signaling a fund outflow from the asset.

Additionally, use the MFI indicator with other technical indicators, as well as candlesticks and chart patterns.

Volume Weighted Average Price (VWAP)

VWAP, like the Simple Moving Average (SMA), calculates a weighted average price based on trading volumes. SMA measures the average value of a specific price type over a set period.

Volume Weighted Average Price usually signals:

• An uptrend: During an uptrend, the asset price will typically be above the VWAP line.
• A downtrend: Conversely, in a downtrend, the asset price will be below the VWAP line.

VWAP can reinforce existing trends when used with SMA, charts, and candlestick patterns. VWAP acts as a dynamic support or resistance level, anticipating price rebounds and can also primarily used for identifying trends.

Accumulation/Distribution (A/D) Indicator

The A/D indicator was initially created to measure trading volume in the stock market. Its effectiveness led to its adoption in other markets as a predictive tool.

The A/D indicator shares similarities with the On-Balance Volume (OBV) indicator. Both tools analyze the inflow and outflow of funds into an asset by comparing closing prices to the highs and lows within a specified range.

A/D Indicator usually signals:

• Upward Trend: An increasing A/D indicator value confirms an upward trend.
• Downtrend: A decreasing A/D indicator value confirms a downtrend.
• Bearish Divergence: If the asset price rises but the A/D indicator does not follow, it signals a potential downward trend reversal.
• Bullish Divergence: If the asset price falls but the A/D indicator does not follow, it signals a potential upward trend reversal.

The Chaikin Oscillator

The Chaikin Oscillator, developed in the 1970s, is derived from the Accumulation/Distribution (A/D) indicator. It calculates the difference between a 3-period Exponential Moving Average (EMA) and a 10-period EMA.

Unlike the Simple Moving Average (SMA), the EMA places more weight on recent price changes, providing a smoother representation of price dynamics.

The Chaikin Oscillator incorporates trading volume data, enabling traders to identify potential price reversal signals through divergences.

• Positive Divergence: A positive divergence between the oscillator and price during an uptrend signals a potential sell opportunity.
• Negative Divergence: A negative divergence between the oscillator and price during a downtrend suggests a potential buy opportunity.

For more accurate analysis, consider using the Chaikin Oscillator in conjunction with RSI, Stochastic, or Bollinger Bands.

Volume Relative Strength Index (RSI)

The volume relative strength index measures changes in a currency pair’s traded volume, similar to the traditional RSI. However, unlike RSI, VRSI focuses on volume changes rather than price fluctuations.

Interpretation

• Bullish Market: A VRSI reading above 50% indicates a bullish market, signaling traders to buy.
• Bearish Market: A VRSI reading below 50% suggests a bearish market, signaling traders to sell.

VRSI Formula:

VRSI = 100 – [100 / (1 + VoRS)]

Where:

VoRS = Volume Relative Strength over the given period
VoRS = Average of up volumes / Average of down volumes

Conclusion

Volume indicators are essential tools for Forex traders seeking to understand market sentiment, momentum, and potential trend reversals. By analyzing volume data, traders can make more informed decisions about entering or exiting positions.

These indicators measure buying and selling pressure, identify supply and demand dynamics, and provide signals for market continuation or reversal.

By effectively interpreting these indicators, traders can enhance their trading strategies and improve their chances of success in the Forex market.