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An entire book could be written on volume, particularly volume analysis. For now, let’s focus on the basics. Volume defines the number of transactions a market has experienced over an established period. The daily chart depicts price action throughout a single trading day. Have you noticed the green and red bars which materialize below individual candlesticks? These bars reflect volume. The volume below a candlestick of any timeframe is a graphical representation of the number of shares a market traded between its open and close, relative to the timeframe. 

For example, a one-minute candlestick chart will display the number of shares transacted each minute. A four-hour candlestick chart will display the number of shares transacted every four hours. A daily candlestick chart will display the number of shares transacted each day. A weekly candlestick chart will display the number of shares transacted each week.

Figure 1.1 Volume Analysis 

We want the volume to confirm a market’s price trends. If an uptrend is in operation, the volume should be greater on up days than on down days. Such an occurrence reflects strong buying pressure that confirms uptrending prices. If a downtrend is in operation, the volume should be greater on down days than on up days. Such an occurrence reflects strong selling pressure that confirms downtrending prices. If the volume does not confirm a trend, we have an anomaly. We won’t discuss volume-to-price anomalies quite yet. Just know that: volume should confirm a trend. 

Think of it this way. If an uptrend is in motion, but volume is greater on down days than on up days, we should think, “this uptrend may stall soon.” If an uptrend is strong, buying pressure must overwhelm selling pressure. If on down days, selling pressure overwhelms buying pressure during an uptrend, sellers must be comfortable enough to open a position at the current price level with the expectation of a future profit. In addition, traders holding shares of the underlying stock are taking-profit. If a downtrend is in motion, but volume is greater on up days than on down days, we should think, “this downtrend may stall soon.”

If a downtrend is strong, selling pressure must overwhelm buying pressure. If on up days buying pressure overwhelms selling pressure during a downtrend, buyers must be comfortable enough to open a position at the current price level with the expectation of a future profit. In addition, traders short on the underlying stock are likely taking-profit.

For an uptrend to persist, demand > supply. For demand to be greater than supply, buyers must overpower sellers. For a downtrend to persist, supply > demand. For supply to be greater than demand, sellers must overpower buyers. 

Volume can sometimes be deceitful. Still, we must be cognizant of the importance of volume and how it can be assessed to improve our analytical abilities. Volume analysis allows us to evaluate price areas where demand or supply overpower one another. In addition, we can analyze volume to confirm trends, identify trend exhaustion, and even confirm price reversals. 

We know that bearish retracements manifest during an uptrend. However, bearish retracements during a strong uptrend should occur on below-average volume. If the volume is high during bearish retracements of an uptrend, we know that sellers are entering the market aggressively and bullish traders are taking-profit. We know that bullish retracements manifest during a downtrend. Bullish retracements during a strong downtrend should occur on below-average volume. If the volume is high during bullish retracements of a downtrend, we know buyers are entering the market aggressively, and short-sellers are taking-profit. 

For us to establish an average volume metric, we can implement a moving average of volume (usually 14 – 28 sessions) over an established amount of sessions.

Figure 1.2 Volume Analysis with a Volume Moving Average

A volume moving average allows us to quantify high, low, and average volume. It’s important to use a VMA with your volume analysis. Why? We can precisely define volume conditions in our trading system when using a VMA instead of just eyeballing volume.

For example, if volume for a session is 1.5x greater than the average we might consider volume “high” that session. If volume is 1/2 the moving average for a session we might consider volume “low” for that session. This allows us to quantify our volume analysis and build a trading system/strategy predicated on it.

Volume must be analyzed against the correlative price action. High volume occurring for a session with a small price range (high price minus low price) is anomalous. In addition, low volume corresponding with a large price range is anomalous. Why?

The Law of Effort and Result.


The law of effort and result proposes that for there to be a result, there must be effort—the greater the effort, the greater the result. The price action of a market must represent the simultaneous volume action. Volume and price action must be in unison, thereby confirming one another. Effort = volume and result = price action. When disunity between effort and result exists, we have an anomaly.

A wide-spread candlestick (result) should be produced from high volume (effort). A trend with candlesticks increasing in spread (result) should be produced from increasing volume (effort). A wide-spread candlestick is validated by high volume, and a narrow-spread candlestick is validated by low volume. Therefore, when a wide-spread candlestick materializes on low volume, an anomaly is present, and you should proceed cautiously. Conversely, when a narrow-spread candlestick forms on high volume, an anomaly is present, and you should proceed cautiously. 

Think of it this way. A wide-spread candle reflects a substantial price move in the market. Prices either increased considerably or decreased considerably. For a strong price increase, there must be high demand; traders are buying the market more intensely than they are selling. For a strong price decrease, supply must be increasing; traders are selling the market more intensely than buying it. When we observe strong price increases, we should expect to see high volume for the sessions. It does not make sense why a strong price move would occur on low volume. A wide-spread candle on an up day reflects strong demand, but low volume tells us that demand was not all that strong. A wide-spread red candle on a down day reflects increasing supply, but low volume tells us that selling intensity was not all that strong.

Volume is meaningless without price action analysis.

Figure 2.14 Volume Increasing During Downtrend – Volume Analysis

Volume confirming downtrend (NYSE: HD)

Figure 2.14 shows volume increasing as prices downtrend. Volume is low during bullish pullbacks. This is good; buying intensity is weak. The blue line resembles the twenty-eight session moving average of volume. We can see how volume, relative to the moving average, increases during price declines and decreases during bullish pullbacks. This indicates a strong downtrend; selling intensity is increasing. Selling intensity must diminish and become inferior to buying intensity for a bullish reversal to occur and persist. Selling and buying intensity must reach equilibrium for prices to institute a sideways trend. 

The most important data in the figure is the volume moving average. A session’s volume can measure at, below, or above the moving average; no other alternative exists, and we can precisely define a set of criteria. For example, assume an uptrend is in motion, and a red candlestick with a range 2x greater than the average daily range forms on volume higher than the VMA. If we consider this an exit signal, we can easily incorporate the criteria into a testable trading strategy.

Figure 2.15 Volume Increasing During Uptrend – Volume Analysis

Volume confirming uptrend (NASDAQ: WLDN)

Figure 2.15 shows higher volume, on average, during price sequences which continue the uptrend. Also, volume is lower than average during sequences of price declines. Due to this, we can conclude the uptrend is strong when analyzing the price trend and volume in conjunction. Volume during pullbacks and retracements is low. Volume, when prices are moving higher, is above average.

An example of an objective rule might include exiting a position when three consecutive sessions form on volume lower than a VMA.

Volume Deception

Volume can be deceiving – particularly in the current market. Uptrends persist despite lower volume on sessions progressing the uptrend, and higher volume on sessions closing against the uptrend. This sequence counters everything we have learned in the article. 

Figure 2.16 Volume Increasing During Bearish Retracements of Predominant Uptrend, and Decreasing During Continuation of Predominant Uptrend

Volume not confirming a trend (NYSEARCA: SPY)

Figure 2.16 shows an uptrend. However, bearish retracements of the uptrend transpire on above-average volume, while continuation of the uptrend transpires on below-average volume.

In March, we can observe extended lower wicks at the bottom of the bearish retracement. This indicates increased buying intensity near the intrasession low. Therefore, buying volume significantly contributed to the total volume for the session. Still, it is difficult to wrap our heads around the fact that prices continued the predominant uptrend on below-average volume and bearishly retraced on above-average volume.

We don’t have to trade this trend. There are thousands of securities to trade. We know how to analyze volume to evaluate the strength of a trend. If the metric we apply is not satisfied, regardless of whether a trend continues, we don’t trade. If our “edge” is not there, we don’t open a position. The trend may continue despite incongruent volume. That’s fine. Our criteria for opening a position and taking on risk were not satisfied. We want to identify setups where our metric (edge) is satisfied. When our edge is present; it is worth the risk of opening a position.

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