Volume price analysis (VPA) is a technique that combines the study of price and volume to identify trading opportunities and confirm market trends. VPA is based on the idea that volume is the fuel that drives price movements, and that changes in volume can indicate changes in supply and demand. By analyzing how volume relates to price, traders can gain insights into the strength and direction of a market, as well as spot potential reversals and breakouts.
What is Volume Price Analysis?
Volume price analysis is a form of technical analysis that uses volume data to interpret price action. Volume data shows how many shares or contracts are traded in a given period of time, such as a day, an hour, or a minute. Volume data can be displayed as a histogram below the price chart, or as a line that tracks the cumulative volume over time.
VPA assumes that volume reflects the emotions and intentions of traders, and that it can reveal hidden clues about the market sentiment. For example, high volume indicates high interest and activity in a market, while low volume suggests low interest and activity. Similarly, rising volume indicates increasing momentum and conviction in a price trend, while falling volume suggests decreasing momentum and conviction.
VPA also looks at how volume changes relative to price changes. For example, if the price rises on high volume, it means that there is strong buying pressure and demand for the asset, which is bullish. On the other hand, if the price falls on high volume, it means that there is strong selling pressure and supply for the asset, which is bearish. Conversely, if the price rises or falls on low volume, it means that there is weak buying or selling pressure and demand or supply for the asset, which is neutral or indecisive.
By comparing volume and price patterns, VPA can help traders identify key support and resistance levels, trend confirmations and reversals, breakouts and breakdowns, divergences and convergences, and other trading signals.
How to Use Volume Price Analysis?
To use VPA effectively, traders need to follow these steps:
- Identify the prevailing trend of the market. This can be done by using trendlines, moving averages, or other indicators that show the direction and strength of the price movement.
- Analyze the volume patterns in relation to the price trend. This can be done by looking at how volume changes as the price moves up or down along the trendline or moving average. Traders should look for signs of increasing or decreasing volume that confirm or contradict the price trend.
- Look for trading signals based on volume and price patterns. This can be done by looking for specific VPA patterns that indicate potential entry or exit points for trades. Some common VPA patterns are:
- Volume Breakout: This occurs when the price breaks out of a consolidation or trading range on high volume. This indicates a strong breakout with high momentum and conviction. Traders should look for a continuation of the breakout direction.
- Volume Climax: This occurs when the price makes an extreme move on very high volume. This indicates a possible exhaustion of the current trend with high emotion and panic. Traders should look for a reversal or correction of the price movement.
- Volume Divergence: This occurs when the price makes a higher high or a lower low but the volume makes a lower high or a higher low. This indicates a weakening of the current trend with low momentum and conviction. Traders should look for a reversal or correction of the price movement.
- Volume Test: This occurs when the price retests a previous support or resistance level on low volume. This indicates a lack of interest and activity at that level. Traders should look for a bounce or rejection of the price from that level.
Benefits and Limitations of Volume Price Analysis
VPA has several benefits for traders, such as:
- It can help traders confirm and validate market trends and signals.
- It can help traders identify potential reversals and breakouts before they happen.
- It can help traders gauge the strength and conviction of market movements.
- It can help traders avoid false signals and whipsaws.
However, VPA also has some limitations, such as:
- It can be subjective and open to interpretation depending on how traders define high and low volume.
- It can be lagging and delayed as volume data may not reflect real-time market activity.
- It can be noisy and misleading as volume data may be affected by external factors such as news events, market hours, and liquidity.
- It can be insufficient and incomplete as volume data may not be available or reliable for some markets or instruments.
Volume price analysis is a powerful technique that can help traders understand and trade the market better. By combining the study of price and volume, traders can gain insights into the supply and demand dynamics of the market, as well as the emotions and intentions of other traders. VPA can help traders confirm and validate market trends and signals, identify potential reversals and breakouts, gauge the strength and conviction of market movements, and avoid false signals and whipsaws. However, VPA also has some limitations that traders need to be aware of and overcome. Traders should use VPA in conjunction with other forms of technical analysis and fundamental analysis to maximize their trading performance.
Here is a link to the ThinkorSwim indicator I made based on some of the principles of VPA: https://tos.mx/1TQFZNC Here is the link to my favorite book about VPA: https://amzn.to/3OK4RFp How to interpret the WST VPA indicator: https://wstrades.com/wst-vpa-indicator/