Volume is an important concept in the financial market that has been embraced by both investors and traders. In her book on the topic, Anna Couling mentioned that traders who focus on volume tend to do relatively well than those who ignore it.
But to understand the volume with the naked eye is not easy (as it could be to recognize some patterns in the price action strategy), and for this we have to rely on trading indicators. Some perform better than others, also depending on the situation, and therefore also in this case the choice cannot be made lightly.
In this article, we will look at some of the best volume indicators that you should use in day trading.
Why volume is important in trading
Volume is an important concept because it shows the weighting of a price movement. For example, if a stock moves from $10 to $15 on low volume, it means that the strength of this price action is not as strong.
On the other hand, if the stock makes this price action in a high volume environment, it means that there is more demand. As such, it is possible that the price will continue rising as long as there is strong volume.
The same situation can be said about volume when there is selling pressure. For example, the price of Bitcoin declined sharply in May 2021 as the volume of selling increased.
» Related: Understanding Stock Volume
With this in mind, let us look at some of the best volume indicators you can use in trading. In this list, the details of each indicator will be relatively brief since we have already covered them in detail before. You can use the links to find more details about the indicators.
Volume indicators: which are the best?
The Volume-Weighted Average Price (VWAP) is a popular indicator among day traders. As the name suggests, the indicator seeks to find the volume-weighted average price of an asset in a certain session.
It does this by averaging the closing price of closing prices during the period while putting more emphasis on periods with relatively higher volume. In general, traders will often buy an asset whenever the price is above the VWAP indicator and short it when it crosses the indicator going downwards.
Volume-Weighted Moving Average (VWMA)
The VWMA is one of the several types of moving averages. The other popular types of moving averages are exponential, simple, weighted, and smoothed among others. As the name suggests, the VWMA indicator is a type of MA that includes volume.
It is similar to the simple moving average (SMA) indicator with the only difference being that it has a volume aspect. During its calculation, each price is given a certain weight during the period. For example, the price and weight of the asset are considered at all levels of calculation.
Traders can use The VWMA indicator just like other moving averages. You can use it to identify bullish and bearish crossovers. You can also use it in trend following and to find reversals. The chart below shows the 20-day and 50-day VWMA applied on the BMW stock.
Money Flow Index (MFI)
The Money Flow Index (MFI) is an indicator that has a close resemblance to the Relative Strength Index (RSI). When applied in a chart, it is a single line that has overbought and oversold levels.
The indicator was created by Gene Quong and is calculated using several steps. First, one needs to calculate the typical price by adding the high, low, and close and then dividing by three. Second, the person calculates the raw money flow by multiplying the typical price with the volume. Next, you find the money flow ratio. The MFI is then calculated by saying 100 minus 100/(1+ Money Flow Ratio).
Since the MFI indicator resembles the RSI, you can use it in a similar method. You can use it to find overbought and oversold levels. You can also use it to find bullish and bearish divergences. Some traders also use it in trend following. The chart below shows how the MFI indicator looks like.
Accumulation and distribution indicator
The A/D indicator was developed by Marc Chaikin. The goal of the indicator is to find out whether an asset is being accumulated (being bought) or being distributed (being sold). As a trader, you should always buy an asset that is being accumulated and short the one being distributed.
The indicator is calculated by first looking at the money flow multiplier followed by the money flow volume. The final stage is where you get the ADL line. The chart below shows how the accumulation and distribution indicator looks like.
Developed by Stephen Klinger, this indicator helps traders to predict the long-term trends in money flow while showing short-term fluctuations. It can also be used to predict reversals. When applied in a chart, the indicator is made up of two lines of different colors.
You can use the Klinger Oscillator in several ways. First, you can use it to identify reversals. These reversals usually happen when the two lines of the indicator makes a crossover. Second, you can use it in trend following and also combine it with other technical indicators. The chart below shows the Kilinger Oscillator applied in a chart.
On Balance Volume (OBV)
The OBV indicator is a breadth indicator that is mostly used in index trading. It is calculated by measuring the buying and selling pressure as a cumulative indicator, and then by adding up days and subtracting down days in a session.
You can use the indicator to identify the trends in the market. Also, you can use it to find divergences and identifying buying and selling prices.
Other volume indicators
There are several other popular volume indicators in the market. Some of those we have not mentioned here are the negative volume index indicator, volumes, and the force index.
Volume is a very important concept in trading, especially to understand the strength of a trend. Neglecting it can often lead to wrong decisions. We have seen together the most common indicators, and also the most effective ones, which can help us to identify entry and exit points, or chances to short.
Our advice, as always, is to try them in a demo account and find the one that best suits your trading strategy.
External useulf resources
- Using Volume Trading Strategy to Win 77% of Trades - Trading Strategy Guides