Volume Patterns

No matter the instrument you are trading, it’s imperative to be able to read the signs of market strength and weakness as detailed from the past actions of market participants.  

 

There are three main types of volume, and all must be discerned relatively. Regardless of the timeframe you use for your charting tool(s), use a 20-period moving average for volume to best establish what volume value is ‘relative’. 

 

Volume Rules

 

Whenever volume is above this moving average, that signifies that specific volume candlestick has a larger volume value than the average of the past 20 volume periods. A large volume candlestick that is magnitudes larger than its volume moving average is called a volume spike. When a volume candlestick is more than 3x its moving average, then it is classified as a volume spike (however on higher timeframes such as the daily chart and above, a volume spike is classified as 2x the moving average). 

 

  • When there is a major volume spike that coincides with an incredibly volatile price candlestick, that tends to signify that a reversal is likely. Especially so if there is a large wick/tail on the same price candlestick. 

 

  • When there is a minor volume spike (or volume is above the moving average) and a strong price candlestick that tends to signify strength in the price move’s direction.

 

  • When there is barely any volume transacted (volume is below the moving average), this signifies that the market move made during that volume period was made with little conviction. This can at times signify a weakening trend

 

As can be seen from the chart above, every time that volume spiked to a level of 2x the volume moving average on a volatile downward move— price moved higher each and every time except for the volume candlestick indicated by the white arrow that corresponded to a price point in which price continued lower.

 

These patterns are not black and white, rather they are market tendencies. This means that just because you see one of these volume candlestick patterns, that does not guarantee that price will move in that direction. Rather, it means that there is more of a likelihood that what is detailed in this section will occur in the future.

 

Volume Location

 

Another common volume pattern that you should look out for is volume location. A strong uptrend will typically have a large amount of buying occur near the base of the uptrend and not at a later point in the uptrend unless the uptrend is reversing or turning into a stage of consolidation/ranging. 

 

Notice on the chart above how volume spikes that occurred later in a trend tended to lead to a short-term retracement/reversal. This is indicated by the first two white arrows from left to right.

The third white arrow denotes a time where price was trending lower and then a large volume spike occurred on a candle in which price also moved upward, which is a common occurrence at the start of a new uptrend.

 

Moreover, know that strong volume and a strong price move tend to lead to a continuation during the early stages of a trend — however a common pattern to look out for is a rapid price move that had a large amount of volume that then turned into a phase of consolidation: as this can be a strong sign of a soon to be Bart move. A great example of this can be seen from the 9th on the chart above. The large volume spike and bullishness eventually led to a price range of many wick highs, and eventually price fell in a bart-like pattern. 

 

Volume Trends

 

Now that we’ve covered how to interpret individual volume candlesticks, let’s take a deeper dive into volume trends. Do this by looking an uptrend or downtrend, and contrast the amount of volume transacted on both. An example will be provided below.

In period 1, we can see a price move that slowly inches higher — however the amount of volume transacted during said uptrend was minimal. In period 2, we can see a swift price move lower that had on average 2-3x more volume than the average candlestick in period 1.

This tells us that the sellers are likely stronger than the buyers and that seller interest is high and buyer interest is low. Consequently, the downtrend was likely to continue — and it did.

 

This is because as a standard rule of thumb in volume analysis: an increase in volume whilst price is trending shows that there is high interest for the current trend, raising the probability that the trend will continue. 

Conversely, a decrease in volume while price is trending shows that there is a low amount of interest for the current trend, so take this as a sign that the trend is not likely to continue. 

 

Volume in Totality 

 

Using the three sections of volume above, let’s analyze an uptrend/downtrend that is likely to continue and an uptrend/downtrend that is likely to reverse.

 

A downtrend that is likely to continue

  • Strong volume at the beginning of the trend — this could be a volume spike reversal that finishes a previous uptrend or a high volume beginning move lower
  • Price moves on high volatility at the onset of the trend, and then average/above-average volatility during the move lower
  • Moves back upward carry little volume and have volume spikes at market tops

 

A downtrend that is likely to reverse

  • Weak volume at the beginning of the downtrend
  • Price moves on low/average volatility at the onset of the trend, and then low/average volatility during the move lower — and any high volume downward move has a weak price candlestick with a large wick (this will be covered in the next section)
  • Moves back upward carry average/above-average volume and have volume spikes at previous market bottoms where the move higher began

 

An uptrend that is likely to continue

  • Strong volume at the beginning of the trend — this could be a volume spike reversal that finishes a previous downtrend or a high volume beginning move higher
  • Price moves on high volatility at the onset of the trend, and then average/above-average volatility during the move higher
  • Moves back lower carry little volume and have volume spikes at market bottoms

 

An uptrend that is likely to reverse

  • Weak volume at the beginning of the uptrend
  • Price moves on low/average volatility at the onset of the trend, and then low/average volatility during the move higher — and any high volume move higher has a weak price candlestick with a large wick
  • Moves back lower carry average/above-average volume and have volume spikes at previous market tops where the move lower began

 

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