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August 23, 2006

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Revealing the Hidden Secrets of Analyzing Volume in the FOREX Markets using Volume Spread Analysis

Name: Todd Krueger

Company: TradeGuider Systems, LLC

Learn More About Today's Author

Revealing the Hidden Secrets of Analyzing Volume in the FOREX Markets using Volume Spread Analysis

Most retail traders who are trading the FOREX markets are using one, or both, of the widely known approaches used to analyze a market; fundamental analysis and/or technical analysis. There are many different methods that can be used in each approach, but generally speaking, fundamental analysis is concerned with the question of why something in the market will happen and technical analysis attempts to answer the question of when something will happen. There is, however, a third approach that can be used to analyze the FOREX market which combines the best of both fundamental and technical analysis into a singular approach that answers both questions of “why” and “when” simultaneously; this methodology is called Volume Spread Analysis.

It is a common belief among traders that since there is no centralized exchange in the FOREX markets, that there is no possible approach that can be used to analyze volume. While it is true that a trader cannot receive traded volume figures, it is still possible to analyze the amount of activity on each and every price bar; one just needs to have the right tools for the job. This article will introduce the reader to the only tool that will do this critical analysis effectively, Volume Spread Analysis (VSA); as well as provide the necessary background information needed to understand how, and why, this approach works. We will also look at several chart examples to show the reader this methodology in action.

What is Volume Spread Analysis?

Volume Spread Analysis (VSA) seeks to establish the cause of price movements. The “cause” is quite simply the imbalance between supply and demand in the market, which is created by the activity of professional operators (Smart Money). Who are these professional operators? In any business where there is money involved and profits to make, there are professionals. There are professional car dealers, diamond merchants and art dealers as well as many others in unrelated industries; all of these professionals have one thing in mind, they need to make a profit from a price difference to stay in business and the financial markets are no different. Doctors are collectively known as professionals, but they specialize in certain areas of medicine, again the financial markets have professionals that specialize in certain instruments as well; stocks, grains, FOREX, etc. The activity of these professional operators, and more importantly their true intentions, are clearly shown on a price chart if the trader knows how to read them.

VSA looks at the interrelationship between three variables on the chart in order to determine the balance of supply and demand, as well as the probable near term direction of the market. These variables are the amount of volume on a price bar, the price spread or range of that bar (do not confuse this with the bid/ask spread) and the closing price on the spread of that bar (refer to chart 1). The significance and importance of volume appears little understood by most non-professional traders, perhaps this is because there is very little information and limited teaching available on this vital part of chart analysis. To interpret a price chart without volume is similar to buying an automobile without a gasoline tank. For the correct analysis of volume, one needs to realize that the recorded volume information contains only half of the meaning required to arrive at a correct analysis. The other half of the meaning is found in the price spread (range) along with the corresponding closing price. Volume always indicates the amount of activity going on, the corresponding price spread shows the price movement on that volume.

 How Can we View Volume in FOREX?

At this point it is important to define the volume figures that we can receive and analyze in the FOREX markets. The volume histogram for FOREX issues represents the number of transactions or ticks and not true "trade size" activity. It's much like most futures contracts, where the volume histogram reflects the volume of transactions or updates during each given interval. First of all you have to realize that the “Smart Money” or “Professional money” is very active in the FOREX market. Professional money is made up of many sources including trading syndicates, large financial institutions, certain funds such as “The Quantum Fund” operated by George Soros, and many large institutional banks. These individuals or organizations are very secretive in their dealings, as they do not want others to know what they are doing. Tick volume is added to the price movement on every price tick up or down, we get one tick for each transaction. Bear in mind that from the tick volume created, approximately 90% will be from professional money and their dealers. When these very large orders go through, they have a following, the same as the futures pits; this automatically creates more ticks, hence higher volume. When we hear of strength and weakness in a currency, this is nothing more than professional support or professional supply and it can clearly be seen on the price chart when the trader is properly trained in the methodology. For more in-depth information on tick volume, please click this link to receive a free FOREX fact sheet which goes into much more detail on how to receive this information on your charts.

A Long and Proven Pedigree

VSA is the improvement upon the original teaching of Richard D. Wyckoff who started as a stock runner at the age of 15 in 1888. By 1911, Mr. Wyckoff was publishing his weekly forecasts and at the height of his popularity, it was rumored that he had over 200,000 subscribers. In 1931 he published his correspondence course which is still available today. In fact, the Wyckoff method is offered as Graduate level curriculum at the Golden Gate University in San Francisco. Richard Wyckoff is said to have disagreed with market analysts who traded from chart formations that would signal whether to buy or sell. He estimated that mechanical or mathematical analysis techniques had no chance of competing with good training and practiced judgment. It was this background from Richard Wyckoff that Tom Williams, a former syndicate trader for 15 years in the 1960’s-1970’s (professional operator in the stock market), enhanced the work started by Wyckoff. Mr. Williams further developed the importance of the price spread and its relationship to both the volume and the close. Williams was in a very unique situation whereby he had the ability to watch the results on the price chart of the syndicate’s trading activity, and the resulting price gyrations derived from their actions, on the stocks they were accumulating and distributing for profits. In 1993, Williams made his work available to the public when he published his methodology; that book today is named “Master the Markets”.

Why Volume Spread Analysis Works

Every market, including FOREX, moves on supply and demand. VSA identifies supply and demand from professional operators. If there is more buying than selling then the market will move up. If there is more selling than buying, the market will move down. Before the trader thinks that the markets are this easy to read though, there is much more going on in the background than this simple logic; this is the important part that most non-professional traders are unaware of! The underlying principle stated above is correct but supply and demand actually work in the markets quite differently. For a market to trend up, there does have to be more buying than selling, but the buying is not the most important part of the equation as the price rises. For a true uptrend to take place, there has to be an absence of major selling (supply) hitting the market. Since there is no substantial selling to stop the up move, the market can continue up. What most traders are completely unaware of is that the substantial buying has already taken place at lower levels as part of the accumulation phase. And the substantial buying from the professional operators actually appears on the chart as a down bar/s with a volume spike/s. VSA teaches that strength in a market is shown on down bars; weakness is shown on up bars. This is exactly opposite to what most traders think they know as the truth of the market! For a true down trend to occur, it happens because there is a lack of substantial buying (demand) to support the price. The only traders that can provide this level of buying are the professional operators, but they have sold at higher price levels earlier on the chart during the distribution phase of the market. The professional selling is shown on the price chart during an up bar/s with a volume spike/s, weakness appears on up bars. Since there is now very little buying occurring, the market continues to fall until the professional operator buys into the selling, this is normally created by bad news being released, this news will encourage the mass public (herd) to sell (almost always for a loss), again this professional buying happens on down bars. This activity has been going on for well over 100 years yet most retail traders remain uninformed about it, until now!

An Example of Weakness Appearing on an Up Bar

For this example we are going to look at the GBP/USD chart on a 180 minute timeframe. While it is critically important to analyze a market on multiple timeframes to arrive at an accurate assessment of supply/demand from the smart money, it is unfortunately impractical to show this in a brief article explaining the methodology. Please click here to view a free online web seminar where the FOREX markets are analyzed live every Thursday.

We will look at how weakness appears, this happens on an up bar and we will be looking at what this professional activity looks like on the price chart. In this example we will look at multiple bars to show where this professional selling is hidden to most unaware observers. On this chart (see chart 2) we will look at the bars labeled 1, 2 and 3 and explain what is happening as the market is showing supply from the professional operators. On bar 1 we see the price move resulting from the CPI report (United States), an up market does not like wide spread (or greater) up bars on high volume (or greater) as this shows potential supply from the smart money. This bar has an ultra-wide spread of 120 pips on high volume, this alerts us to the fact that we may have professional supply entering the market and we must then watch the following bars carefully in order to confirm that this is true. On the following bar (bar 2) notice how the spread narrows considerably, on another up bar, but this bar closes in the middle with an increase in volume; this is indicative of professional selling. The window of opportunity for the smart money to sell their holdings was created by the release of the CPI report and the flood of retail traders into the long side of the market. Who was selling to these new longs; the smart money! On August 17th (bar 3) at 5 AM C.S.T. the distribution process is completed. We see another up bar with heavy volume closing on the low area of the bar, this is a classic upthrust that allows the smart money to distribute any remaining inventory and positions them for the upcoming downside move. Weakness appears in the market on up bars, it has to when you understand how the smart money operates. They cannot wait until the market tops out to liquidate their long positions and establish their new short positions; this would drive the price down against them as they try to sell their massive positions into a down move, which is bad business! The market has to move down now, as there won’t be any professional buying to support this price level. The professional’s have already sold, this has pushed their supply onto the market, and more importantly the retail trader who will soon be locked into a losing position.

An Example of Strength Appearing on a Down Bar

We are now going to focus on the 2 down bars on August 18th that closed at 8 AM and 11 AM C.S.T. (see chart 3). In the near background, the previous high on August 16th was 1.9024 and the market fell hard (we know why from the previous example) and culminated in a wide spread down bar on high volume (bar 1). When we look even closer, we can see that the price closes in the middle of the bar (at 1.8808); this alerts us that there is potential professional buying occurring on this bar. The very next bar (bar 2) is another down bar but this time there is ultra-high volume and the price is again closing in the middle of the bar, this confirms the large amount of demand (buying) coming into the market from the professional operators. To understand why this is true, we must revisit a previous statement, professional buying occurs on down bars generally on bad news when there has already been a down move in the background. These traders trade with such large positions that they must buy into a down move, if they didn’t do this and they waited until the market started to move up before establishing their long positions they would quickly drive the price up against their own buying, thereby reducing or eliminating their overall profit potential on the trade. To close in the middle of the bar with ultra-high volume present, confirms this hidden buying. Think of it from a logical perspective; if all of this volume represented selling, the bar could not close well off the lows into the middle of the bar. Who are the only traders that can create this kind of volume in the market? This is professional buying occurring, the market must now move up because there will be no supply placed on the market from the professional operator as the market moves up, they have already established their long positions after buying from the panicked herd.

VSA is the Solution to Trading All Markets including FOREX

The reality is that most retail traders are told that they can’t analyze volume in the FOREX market and because of this misconception; they never realize their full ability to analyze these markets effectively. It is important to note that the focus of this article was on the FOREX markets but VSA is a universal approach that works equally well across all markets and timeframes, it doesn’t matter if you trade FOREX, futures, stocks or commodities in intraday or end-of-day timeframes. This methodology has existed for decades and its grass roots can be traced back well over 100 years! A word of advice to those that want to immediately look at their FOREX chart and try to apply this methodology in their analysis, the “Master the Markets” book is over 190 pages of material that covers this methodology in the detail required to begin to use it successfully in your trading. This article was designed to introduce the importance of analyzing volume in the FOREX market and further study is required to use this methodology to its utmost potential.

All charts courtesy of TradeGuider Systems

About Today's Author

Todd Krueger is a professional trader and CEO of TradeGuider Systems, LLC which provides trading software and education focused on Volume Spread Analysis. Todd has over 20 years of trading experience in the Stocks, Futures and FOREX markets and has been published in SFO magazine and has several upcoming articles in both SFO and Technical Analysis of Stocks and Commodities. He has also been a featured seminar speaker teaching the benefits of VSA on both sides of the Atlantic. For more information visit Todd Krueger can be contacted at or 877-392-3896.

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