When a day trader uses technical indicators they are trying to see into the collective mind of the market to assess its sentiment. Tools like moving averages help us recognize trends amidst volatile price activity. Another way to predict trends is by watching trading volume along with price activity. The use of volume spread analysis in day trading is a skill that a new day trader is wise to acquire in order to have a full set of trading tools and profitable trading strategies.
Introduction to Volume Spread Analysis (VSA)
Along with changes in asset price, the trading volume of futures, currency pairs, and stocks tells you a lot about where the next trend will be as well as its potential strength. Volume analysis simply means examining how many contracts or shares of a given security are being traded over a given period of time. Absolute trading volume is often not so important as the spread of trading volumes over time when analyzed along with price fluctuations. Very commonly an uptick in volume will precede price indicators for a new upward or downward trend.
Key Concepts and Terminology in VSA
When using volume spread analysis a day trader looks for established price ranges for the asset they are trading. Then they follow trading volume per day or whatever time period they are using. Adding this information to sequential closing prices is the next step. The point of using volume spread analysis is that trading volume tells the day trader about the level of interest in an asset. It can be risky to read too much into price fluctuations in a thinly traded market. On the other hand, when more and more trades are being executed and prices start to move up or down, the significance increases greatly.
Identifying Trade Opportunities with VSA
What to make of prices that are rising, falling, or trading sideways is always the puzzle that day traders need to solve. Folks who use a tool like the Doji candlestick know that that when opening and closing prices are extremely close together after the market has been either rising or falling that a market breakout is likely. But what will be the magnitude of that breakout? By adding volume spread analysis to their tool chest a day trader comes to recognize when a substantial marker shift is coming and when to expect only minor market changes.
Integrating VSA with Other Technical Indicators
There are no perfect, infallible technical indicators. Each one provides specific information as a trailing or leading indicator. This is why day traders so often use more than one indicator to guide their trading. Such is the case with a volume spread indicator. Most commonly a day trader who uses volume spread analysis will add trendlines, support and resistance, lines or even candlestick patterns. A time when volume spread analysis can be most effective is when the trader can see a market breakout coming but needs to be more certain of the timing. Here is where adding fundamental information and a wider range of technical indicators can help.
Common Mistakes to Avoid When Using VSA
As we noted, no single indicator is perfect. Thus it is important when using volume spread analysis not to just rely on that indicator. Day traders get into trouble when they misinterpret the volume signals that they see and rely on their VSA without considering other technical indicators or market fundamentals that may be staring them in the face. A good example that comes to mind was how the stock market was flirting with all-time highs in early 2020 while a viral plague was sweeping through China and shutting down cities of millions of persons. Folks who realized the potential significance of this viral pandemic were able to best use tools like volume spread analysis to capitalize when the markets fell off of the cliff and kept falling.