Volume is one of the most important technical indicators in trading, as it provides valuable insights into the strength or weakness of a price move. When combined with price action, volume can act as a sentiment indicator, helping traders understand the market’s underlying mood or sentiment. By analysing volume, traders can determine whether a trend is likely to continue, reverse, or lack conviction.

In this guide, we’ll explore how to use volume as a sentiment indicator to enhance your trading strategies.

What Is Volume in Trading?

Volume refers to the number of shares, contracts, or units traded in a particular asset during a specific time period. High volume indicates significant participation from traders, while low volume signals a lack of interest or conviction. Volume can confirm the strength of a price move, highlight potential reversals, and help traders gauge market sentiment.

How Volume Reflects Sentiment

1. High Volume and Strong Sentiment:
   • When a price move occurs with high volume, it often indicates strong conviction from the market participants, whether it’s a bullish or bearish trend. High volume suggests that many traders are aligning with the current price direction, which supports the continuation of the trend.
   • Bullish Sentiment: A strong upward price movement accompanied by high volume typically signals that buyers are in control and the sentiment is bullish.
   • Bearish Sentiment: A strong downward price movement with high volume suggests that sellers dominate, and the sentiment is bearish.
2. Low Volume and Weak Sentiment:
   • A price move that occurs on low volume often signals a lack of conviction in the market. This can indicate indecision or a lack of participation, and such moves are often more vulnerable to reversal.
   • Bullish Sentiment with Low Volume: An uptrend on low volume might suggest that the buying interest is not strong, and the price rise could be temporary.
   • Bearish Sentiment with Low Volume: A downtrend with low volume can indicate that selling pressure is weak, and the downtrend may not last.
3. Divergence Between Price and Volume:
   • Divergence between price movement and volume is a critical signal for potential reversals. If the price moves in one direction but volume decreases or does not confirm the move, it can suggest weakening sentiment and a potential reversal.
   • Bullish Divergence: When the price makes a new low but volume decreases, it indicates weakening bearish sentiment, and a reversal to the upside may be imminent.
   • Bearish Divergence: When the price makes a new high but volume decreases, it suggests that the bullish sentiment is weakening, and a reversal to the downside may be forthcoming.

Using Volume to Confirm Sentiment in Different Market Conditions

1. Trend Confirmation:
   • Uptrend: In a strong uptrend, increasing volume confirms that more participants are buying, indicating solid bullish sentiment. If the price is rising but volume is decreasing, it may signal a lack of conviction and a potential trend reversal.
   • Downtrend: In a downtrend, increasing volume confirms that more traders are selling, reflecting strong bearish sentiment. If volume decreases while the price is falling, it suggests a weakening of selling pressure and a potential reversal to the upside.
2. Volume Spikes:
   • A sudden increase in volume can indicate a shift in market sentiment, such as a breakout or breakdown. This spike often signals that new information or news has impacted the market, leading to strong buying or selling interest.
   • Breakout: When the price breaks through a key level of support or resistance with a volume spike, it shows strong commitment to the new price direction, signaling that the breakout is likely to sustain.
   • Breakdown: Similarly, a price breakdown below a significant support level on high volume signals that selling pressure is strong, confirming bearish sentiment.
3. Volume-Based Indicators:
   • On-Balance Volume (OBV): OBV is a volume-based indicator that adds or subtracts volume based on whether the price is up or down. It helps traders spot trends and divergence, showing if volume supports the price direction.
   • Accumulation/Distribution (A/D): This indicator measures whether an asset is being accumulated or distributed, based on both volume and price movements. Rising A/D values suggest bullish sentiment, while falling values suggest bearish sentiment.
   • Volume Price Trend (VPT): The VPT indicator combines volume and price to measure the direction of the trend, helping traders assess sentiment strength.

Examples of Volume as a Sentiment Indicator

1. Bullish Trend Confirmation with Volume:
   • Imagine a stock price is rising consistently, and the volume is increasing as the price moves up. This indicates strong buying sentiment, with increasing market participation supporting the bullish trend.
   • However, if the price continues rising, but the volume starts to decline, it signals weakening buying interest and suggests that the trend may be running out of steam, possibly leading to a pullback.
2. Bearish Reversal on Decreasing Volume:
   • If a currency pair is in a downtrend, but the volume is declining as the price moves lower, it indicates that selling pressure is weakening. This suggests that the bearish sentiment might be fading, and the price could potentially reverse to the upside.
3. Volume Spike During a Breakout:
   • Suppose a stock has been trading in a narrow range for weeks, and it suddenly breaks out of this range to the upside with a large spike in volume. This indicates that new buying interest has entered the market, confirming a shift in sentiment towards bullishness. Traders might enter long positions in this case.

Practical Tips for Using Volume as a Sentiment Indicator

1. Use Volume with Price Action:
   • Volume should always be analyzed in conjunction with price action. A price move without adequate volume should be treated with caution, as it often lacks conviction and may not be sustainable.
2. Watch for Volume Divergence:
   • Divergence between price and volume is one of the most important signals in trading. A price move that lacks volume confirmation may signal an impending reversal or the weakening of the current trend.
3. Combine Volume with Other Indicators:
   • Use volume in combination with momentum indicators like the RSI or MACD to get a clearer picture of sentiment. For example, if volume spikes while the RSI is in overbought or oversold territory, this could confirm strong bullish or bearish sentiment.
4. Consider Market Context:
   • Always consider the broader market context when using volume as a sentiment indicator. Volume spikes in response to significant news events, earnings reports, or geopolitical developments can create volatility, but may not always reflect the underlying long-term sentiment.

FAQs

How can volume indicate market sentiment?
Volume shows the level of participation in a market. High volume during a price move suggests strong sentiment and confidence in the trend, while low volume can indicate weak or uncertain sentiment.

What does a volume divergence signal?
A volume divergence occurs when price moves in one direction but volume doesn’t confirm the move. It signals that the current trend may be weakening and a reversal could be near.

Can volume be used as a leading indicator?
Volume is primarily a confirming indicator. However, in some cases, volume spikes or divergence can precede significant price movements, providing early warning signals.

How do I use volume with other technical indicators?
Combine volume with indicators like RSI, MACD, or moving averages to validate price movements. For example, a breakout confirmed by both volume and RSI momentum is more reliable than a breakout on low volume alone.

How do I trade using volume as a sentiment indicator?
Monitor volume to confirm trends, identify reversals, and spot breakouts. Look for increasing volume during price movements in the direction of the trend, and decreasing volume during consolidations or corrections.

Conclusion

Volume is a powerful sentiment indicator that can help traders gauge the strength of a price move and the underlying market sentiment. By combining volume with price action, identifying divergences, and using volume-based indicators, traders can make more informed decisions. Whether confirming trends, spotting reversals, or identifying breakout opportunities, volume plays a critical role in forex and other financial markets.