Understanding volume analysis in trading – Complete guide
When utilized properly, volume can be one of the best indicators to use.
Compared to other trading indicators that mostly rely on lagging data, the volume shows us in real time what other market participants are doing, the areas where they are and are not interested in trading, and much more.
Because of that, volume can be used for plotting your levels on a chart and as heavy confluence during the execution.
In this article, I will cover everything you need to know about using volume in trading.
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Table of Contents
What is the volume in trading?
A volume is the total number of contracts traded during a given period.
The chart above shows 5-minute candles on the E-mini S&P500 futures.
At the bottom table, we can see the volume for each bar.
If we take a look at the last bar to the right, we can see there was 3700 volume traded. Volume doesn’t tell us which side was more aggressive. It shows the number of contracts that changed hands in the last 5 minutes.
When it comes to trading linear futures contracts in crypto, volume is often displayed as the $ value rather than the number of coins traded.
You might be familiar with volume in its simplest form, as the indicator shown above.
For more advanced analysis, volume can be used for the calculation of different indicators and also plotted on the y-axis rather than the x-axis.
We will cover all these later.
Volume and Delta
You will often hear the terms Volume and Delta put together. It is important to understand the difference between them.
We just covered what volume is.
Volume is the sum of all traded contracts for a given period.
One of the small disadvantages when it comes to volume is that you can’t tell which side of market participants was more aggressive.
As you might know, there are two ways you can execute the trade; you can either use a limit or a market order.
Without going too much into the details, as this is something I covered previously in an article about orderflow trading, trades that are using market orders can be categorized as more aggressive and impatient (smaller traders) compared to those that are using limit orders.
To see market orders executed, we can use Delta, which is the difference between finalized orders at bid and offer.
In the image above, you can see in the down column Delta and Volume for each candle.
Delta is coloured blue and red, while volume is grey.
You can also see inside the candles there are Deltas for each price point.
If we are going to take a look at the first candle that has 26k volume and 11k delta.
What this tells us is that from 26k ETH traded, the market buyers were more aggressive, hitting the limit offers.
If we put this within the context, on the price chart, we can see that aggressive market buyers were trying to force a breakout above the trendline but were met with passive sellers, and the market sold off shortly after.
Using delta is great as it can validate things in greater detail, and we can clearly see if one side is more aggressive or not.
On the other hand, for most cases, especially when trading on slightly higher timeframes, volume is more than enough.
One of the most important uses of volume is that it tells us when the buyers or sellers are stepping in at the market.
Of course, it is useless to analyze the volume for each bar and try to deduct what is going on.
A much better and smarter approach is looking at areas where volume is relatively high or low.
If you are a reader of the blog, you might have seen this bell curve diagram in the Auction Market Theory article.
Similar to calculating a fair value for market and volume profiles, we can apply the same method of calculation to the running volume of any asset to see volumes that are outside of the fair value.
As you can see on the chart above, we do not have classic candle colouring for up and down candles, but we only see yellow and blue bars instead.
Blue candles are high relative volume bars, in other words, candles that are above two standard deviations of fair value.
Yellow candles are low relative volume bars, those that are under two standard deviations of fair value.
High relative volume candles are the more important; they are an indication of either breakouts or the end of the moves.
As you can see on the chart above, where I very loosely draw support and resistance levels, high volumes happen at the start of the new moves where large traders initiate the breakouts, but also at the end of the moves where mostly smaller players try to FOMO into continuations.
Low-volume bars are a little less important, and they generally just happen when markets slow down during overnight sessions or weekends.
They tell us that there was a lack of participation; therefore, there will be much interest to trade in the areas where they are at.
If we put them into a bigger context, they can act as good targets for our trades.
Relative volume (rVOL) can be used as a very solid confluence indicator for validating your trading ideas.
You also do not need to go extremely complex. As you can see in the example below, these are the recent movements in GMT and how they could be traded with the very simple use of support and resistance, moving averages and relative volumes.
If you are interested in trying candle-coloured relative volume by yourself, there are plenty of free indicators on Tradingview. I personally use one by Koalafied that colours high-relative volume candles.
Composite volume structure
A composite volume profile is, in my opinion, one of the best tools for you for not only finding levels of support and resistance but also for understanding the market environment.
I have covered it briefly in an article about volume profile, but let’s talk about the basics and fundamentals of why it works in the first place.
Let’s imagine you have a buyer and a seller entering a car market. The buyer wants to buy a specific car and sell wants sell it.
The price of the car is currently at $50,000, and there are many cars sold for that price daily.
The price of the car also fluctuates a little bit almost on a daily basis. Some days there are bids for $48,000, and some days there are offers for $52,000.
Our buyers and seller have time, they do not want to buy a car at fair value, and they would rather wait a little bit to buy or sell a car outside of the current fair value.
This means that if the price of the car would drop to $40,000, our buyer would be more than happy to buy it, and if the price of the car would rose to $60,000, our seller would be more than happy to sell it.
Markets are essentially not that different as buyers and sellers meet every day to trade their idea of fair value for different assets.
As you can see above, we have a daily chart of ETH with the composite volume profile that shows all visible daily candles plotted on the right.
You can essentially make a composite volume profile for any time period you like, and you can do daily, weekly, monthly, quarterly or yearly profiles.
Personally I like to just use all relevant visible bars without splitting them based on weeks or months.
All I personally care about and this is the most important, is to see where volume was traded and where it wasn’t.
For this, we use the terms High Volume Nodes, Low Volume Nodes and Points of Control.
High volume Node (HVN)
High-volume nodes are areas with large executed volumes.
In these areas, you have a large amount of participation, especially from large players, as they are required to execute in areas with a high concentration of volume.
Because of that, prices inside these HVNs tend to be more sideways/rangebound as you have a lot of action going back and forth between buyers and sellers and it takes time until one side becomes more aggressive and drive prices higher or lower.
Coming back to the car example, this is your fair value at $50,000, where you can expect much smaller price fluctuations.
High-volume nodes are often great targets, but executing trades inside them can be tricky as you are more prone to get chopped out, especially when you trade at the point of control.
Point of control (POC)
The point of control is a level inside the high-volume node with the highest executed volume.
This is an area of the most “fair price”.
Points of control are very much the same as HVNs; great for targets but not so much for initiating new trades.
The exception to this rule happens when markets are rallying fast into the Point of control, especially those that were not visited in quite some time.
Pairing those with other things, such as support and resistance, can provide great fading opportunities.
Low Volume Node (LVN)
LVN shows a void in executed volume.
It is characterized by cuts in the profile where very low amounts of volume were executed.
Because of that, prices move quickly through out the low volume nodes, which makes them great areas to enter into positions as I think we can all agree that there is nothing better than entering the trades that move our way quickly rather than sitting in the positions and hoping for the best.
You can see this dynamic highlighted on the chart above as in the blue low-volume areas; prices moved very quickly.
It is simply because there was not much resistance and liquidity to bet against them.
To sum things you, you want to be entering markets at edges of high volume nodes or at POCs if price rally very quickly to them.
For target, you can use the next HVN or POC on your chart.
To demonstrate this, have a look at the ETH chart at the start of 2023.
Now moving forward to current day (March 2023), you can see how these levels acted as support and resistance during the move.
This is without any adjustments just for demonstration purposes, but remember as markets move, the volume is building up at certain levels and your levels should be adjusted.
To get the best value from the composite volume profile, use it for the understanding of the trading environment and combine the levels with general support and resistance areas, moving averages or whatever you use to determine levels.
The exact process of how I use composite volume profile is covered in the Tradingriot Bootcamp.
Volume weighted indicators
There are essentially two main indicators that weigh volume in their calculation and are widely used, the volume-weighted average price (VWAP) and volume-weighted moving average (VWMA), with the former being more popular.
On the chart above, you can see the orange line being 200 VWMA and the blue line a yearly VWAP.
In this article, I will cover VWAP very quickly as it already does have a dedicated article on the website.
VWAP is usually used similar way as the volume profiles, as it is fixed on a certain time period.
Traders use yearly, quarterly, monthly, weekly or daily vwap.
Besides using the vwap as the dynamic level of support and resistance, we can also plot one standard deviation from vwap and treat it as a fair value for the asset, similar to the value area on the volume profile.
When the price is trading inside the one standard deviation bands, we can say it is inside the fair value or in balance.
Once the price trades outside of the bands, it is imbalanced or trending.
We can also use the prior VWAP to see how the price is trading compared to prior periods.
I personally prefer to use the composite volume profile as the range of standard deviation bands from VWAP tends to be often too big and doesn’t show you the full picture.
But the vwaps themselves are a good indicator for dynamic S/R and further confluence for your trades.
Volume is an extremely useful thing to look at when you are trading.
It can be used for spotting large or lack of participation, but also for plotting levels and a better understanding of trading environments.
Most of the professional traders I know use volume in their trading in different forms.
If you are new to it, try implementing the concepts I covered in this article alongside your strategy, and I am sure you will see great results.