Who uses volume as an indicator for entry and why?

[AhmUgEk]

Hi all,

Following on from a handful of backtests, I am starting to question my views on volume and it's impact on the directionality of the market.

I have been backtesting a simple breakout strategy and using volume to confirm a breakout/breakdown, with mixed results. I am using volume above the 50 DMA to trigger a breakout/breakdown confirmation, which is somewhat successful, however, on a number of trades the breakouts are false and lead to losses i.e. me getting stopped out. The thing is my stop is quite flexible and the countermove to the breakout is usually under the influence of lower than 50 DMA volume.

In a live webinar with a successful US firm yesterday evening, one of the head traders stated that volume is less of an influence on price action than it used to be, which got me thinking.

My question is, to those of you that use volume to influence your trading decisions, what are it's merits and pitfalls and would you ever consider trading without consideration of volume?

Any opinions are welcome!

Ahmet

 

[dbphoenix]

Hi all,

Following on from a handful of backtests, I am starting to question my views on volume and it's impact on the directionality of the market.

I have been backtesting a simple breakout strategy and using volume to confirm a breakout/breakdown, with mixed results. I am using volume above the 50 DMA to trigger a breakout/breakdown confirmation, which is somewhat successful, however, on a number of trades the breakouts are false and lead to losses i.e. me getting stopped out. The thing is my stop is quite flexible and the countermove to the breakout is usually under the influence of lower than 50 DMA volume.

In a live webinar with a successful US firm yesterday evening, one of the head traders stated that volume is less of an influence on price action than it used to be, which got me thinking.

My question is, to those of you that use volume to influence your trading decisions, what are it's merits and pitfalls and would you ever consider trading without consideration of volume?

Any opinions are welcome!

Ahmet

I use volume continuously, but you've been misled with regard to just what volume is. Volume is not an indicator, nor is its MA of any importance. Volume is a record of activity and nothing more. Therefore it doesn't "confirm" anything. What moves price is not the level of activity per se but rather the level of demand. It is demand that moves price, which is why price can move quite well with very little volume, and why price can barely budge even though volume -- the level of activity -- may be quite high.

If you want to make use of volume, look at where this volume increase is occurring, i.e., what seemingly important price or level, e.g., the opening high, yesterday's low, an exit from a range. A sharp increase in volume generally means that important money is getting involved, particularly if these levels coincide with something of significance on the daily or weekly chart, and that's something you'll want to know. What small retail traders are doing is of no concern, except perhaps at important turning points.

Click the links below my signature for further information.

Db

 

[AhmUgEk]

Thanks DB,

That makes a lot of sense and is very helpful. I think I missold my point about using it as an indicator. Following the price candle-by-candle, I have noted that in a number of cases a decrease in volume during consolidation and an increase during breakouts has given a level of confirmation that the move is "happening" per se, which is why I have been monitoring it throughout my backtesting. The reason I have used an MA is to give the volume bars a benchmark to relate to, i.e. quickly identify where there is a notable increase in volume over a given period and nothing more.

I will read the threads later on today when I get home, however, with respect to your point about important money getting involved, would you not regard an increase in volume as potential substantiation of a big move, due to the sudden increased supply/demand that goes with this. This takes into consideration your point about retail traders (since we are unlikely to have a huge impact in a reasonably liquid market), as a large volume from an institution will likely be unidirectional(?)

I am undoubtedly thinking of this in a black and white sense, and I am fully aware that there are innumerable factors at play here.

Thank you for your input. I will use it in my study.

 

[dbphoenix]

Thanks DB,

That makes a lot of sense and is very helpful. I think I missold my point about using it as an indicator. Following the price candle-by-candle, I have noted that in a number of cases a decrease in volume during consolidation and an increase during breakouts has given a level of confirmation that the move is "happening" per se, which is why I have been monitoring it throughout my backtesting. The reason I have used an MA is to give the volume bars a benchmark to relate to, i.e. quickly identify where there is a notable increase in volume over a given period and nothing more.

I will read the threads later on today when I get home, however, with respect to your point about important money getting involved, would you not regard an increase in volume as potential substantiation of a big move, due to the sudden increased supply/demand that goes with this. This takes into consideration your point about retail traders (since we are unlikely to have a huge impact in a reasonably liquid market), as a large volume from an institution will likely be unidirectional(?)

I am undoubtedly thinking of this in a black and white sense, and I am fully aware that there are innumerable factors at play here.

Thank you for your input. I will use it in my study.

The "decrease in volume during consolidation and an increase during breakouts" has to do with the "search for value" addressed in auction market theory and doesn't confirm anything other than that there's a lot of activity. However, what breakout watchers often fail to understand is that a large part of all that trading activity consists of selling as well as buying, i.e., the professionals who have been accumulating shares (or whatever) during the consolidation are now profiting from the breakout by selling. If there's sufficient demand to continue propelling price higher, great. Otherwise the "breakout" will fail. It's good to know that the move is "happening", but the move can end just as abruptly as it started with insufficient demand. What matters is the effect that this trading activity has on price, not on whether it's "big" or "small".

As for an increase in volume being substantiation of institutional involvement or the notion that institutional involvement will be unidirectional, again keep in mind that important money isn't buying the breakout; they bought during the consolidation and are taking profits during the breakout, which as often as not they themselves engineered. Demand will fuel a continued increase in price, regardless of the level of volume.

 

[AhmUgEk]

The "decrease in volume during consolidation and an increase during breakouts" has to do with the "search for value" addressed in auction market theory and doesn't confirm anything other than that there's a lot of activity. However, what breakout watchers often fail to understand is that a large part of all that trading activity consists of selling as well as buying, i.e., the professionals who have been accumulating shares (or whatever) during the consolidation are now profiting from the breakout by selling. If there's sufficient demand to continue propelling price higher, great. Otherwise the "breakout" will fail. It's good to know that the move is "happening", but the move can end just as abruptly as it started with insufficient demand. What matters is the effect that this trading activity has on price, not on whether it's "big" or "small".

As for an increase in volume being substantiation of institutional involvement or the notion that institutional involvement will be unidirectional, again keep in mind that important money isn't buying the breakout; they bought during the consolidation and are taking profits during the breakout, which as often as not they themselves engineered. Demand will fuel a continued increase in price, regardless of the level of volume.

That makes a lot of sense,

Thank you DB. I will have a look at auction market theory now.

Is it a fair assumption that if the institutions or big buyers are "engineering" the consolidation, that they are buying several positions in small volume to "hide" in the usual market activity, which is why we see the minor fluctuations in price, creating the perceived support/resistance?

Ahmet

 

[dbphoenix]

That makes a lot of sense,

Thank you DB. I will have a look at auction market theory now.

Is it a fair assumption that if the institutions or big buyers are "engineering" the consolidation, that they are buying several positions in small volume to "hide" in the usual market activity, which is why we see the minor fluctuations in price, creating the perceived support/resistance?

Ahmet

All traders look for the best possible price. But profitable traders -- which usually means professional traders -- are better at it, largely because they have the wherewithal to determine what the best possible price is, or ought to be. The purpose of the range is to enable those who understand how the market works to "do business", that is to trade, to accumulate, to distribute. This is done, generally, quietly. Heavy volume in ranges, much less volume spikes, is relatively rare. This sort of activity doesn't want to attract attention to itself. It is the breakout that attracts attention and provides those who have been buying to begin to sell. But if you add up all the "volume", i.e., trades, that is registered during ranging, or consolidation, it is usually far greater than the volume that is registered during the breakout. This morning, for example, the NQ spent 40 minutes ranging, then six minutes dropping (breaking out). Where do you suppose most of the volume was?

The infatuation with indicators over the past twenty years has prompted traders to focus all their attention on those factors which have nothing to do with price movement and, as a consequence, they have little idea, if any, why price goes up and down. They therefore spend an awful lot of time guessing, and the vast majority of them guess wrong (institutions are not immune to this). I'm sure you've read at least a few articles that go on about how price shouldn't be rising, and yet it rises, and those who bet against those rises ironically fuel the rise since they eventually have to cover, one way or another.

Learn why price goes up and down and you'll have an advantage over nearly every other market participant.

 

[davewin]

To be honest I feel enough to trade without volume because there are so many tools available in the world of trading. However, if anyone can suggest any solid approach using volume, I will be open minded to use the volume for my trading.