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Volume: How It Affects Technical Trading Decisions

Volume: How It Affects Technical Trading Decisions
June 26
17:20 2011

If you’ve traded in enough different markets, you probably already have a feel for how the volume of trade at any given time can present challenges. If a market is very thinly traded, it can sometimes be hard to find other traders willing to take the other side of your position at the price you had in mind. In low-volume markets, the bid-to-ask spreads widen out and market order fills can slip by entire percentage points away from the price where the order was originally placed.

But aside from just investigating what kind of trading environment you may find yourself in, there are other reasons to include a study of market volume in the charts you watch. Some trading software packages include volume data by default on the charts they present: the top portion of the chart will show a basic line chart (or bar chart or candlestick chart) to represent the how the price of the market has been changing over time. Then, coming up from the bottom will be a histogram of vertical rectangles with varying heights. Their heights represent how many contracts were traded in that market each day. The bars themselves might be different colors, with green representing days of net buying activity (more contracts bought than sold) and red representing days of net selling activity.

Be careful to note exactly what these volume numbers represent. For instance, if you are trading in a futures market with several different contracts, each with a different expiration date, for the same underlying asset, note whether the volume on your chart shows just the volume traded in that month’s contract or whether it shows the volume traded in the overall market. For instance, about 75,000 contracts could be traded each day in the December corn futures contract, but if you were watching the overall volume of the corn futures market, your chart might show 350,000 contracts trading in a single day.


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Now – what to do with this data? Aside from giving you a sense how easy or hard it will be to enter and exit trades at favorable prices, charts with volume data included can help a trader develop a bullish or bearish bias toward a market, if he uses technical analysis. A technical chartist will use volume data to confirm (or call into question) significant technical events on any chart. For instance, if a chart shows a trend reversal, it will be a more meaningful call to take a new position in that market if and only if the trend reversal is accompanied by heavy trading volume. If there hasn’t been much trading in that market, the trend reversal could just be a fluke result of choppy, low-volume trading. Higher trading volumes lend credence to basically any technical chart pattern you might look for, and should give you better confidence to place trades when you see the opportunity.

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