Volume analysis is one of the most powerful yet often forgotten aspects of technical trading and is at the heart of financial markets. Price action shows where an asset is moving, volume shows how much weight, conviction and involvement there is for that to translate into that move. Volume data can be defined simply as the total number of shares, contracts or units traded in a given period. By looking at the volume of a security during the period of any price change, market players can see beyond superficial price movement and understand if the trade is driven by smart money or just speculative retail noise.
In volume analysis, the key is validation and momentum tracking. If an asset is showing a strong price breakout above a major resistance level accompanied by exceptionally high volume, then it is showing strong participation from the market and institutional support and the breakout is real. On the other hand, if the price is showing weak or low volume, this is a sign of a false breakout or bull trap and the move is not going to grow on the volume. Similarly, during a trend, a good pullback occurs when volume is low as short-term traders make small profits while trend-continuation happens in the expanding volume phase and the market is still in control.
Traders also depend very heavily on volume divergence to detect if an asset's price is going to change at a new high or low and thus the volume is going to go in the other direction before the stock is seen on a standard price chart. Volume divergence is when an asset’s price is at a new high or low but the volume is going in the other direction. If stock prices are at a higher peak and volume is dropping, it means the buying pressure is too much and institutional interest is decreasing; this is usually the precursor to a sharp correction or a trend change. Understanding these subtle changes allows experienced traders to set up profits or prepare for counter-trend opportunities well ahead of the crowd.
To operationalize these insights, technical analysts use some of the best indicators to track money flows and buying or selling pressure over time. On-Balance Volume (OBV) makes sure volume is a cumulative quantity, adding up volume on up days and subtracting it on down days to show that institutional investors are quietly accumulating or distributing a company stock. Other measures like Volume-Weighted Average Price (VWAP) and the Accumulation/Distribution line, which take into account high, low and closing prices, as well as volume to find the true execution benchmarks and intraday sentiment. Volume analysis takes a trader away from being passive in terms of market view from passive charting to active market understanding.
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