Friday, March 12, 2010

Volume in Forex... Does it Mean Anything ?

Generally speaking, in forex trading we only have one source of information to make trading decisions : price. In the foreign exchange market, due to the lack of a centralized exchange, we lack one of the most useful pieces of information available on the futures and stock markets, volume. This additional data tells us exactly the amount of money (or volume) moved by buyers and sellers which caused any given movement in price within the market at any given time, something which is basic to understand price formations, validate patterns and trade with generally more accuracy. But what is that volume indicator that shows in your trading platform then ? On today's post I will address this question and I will discuss the inherent limitations and uses of "volume" in forex trading.

First of all, it is important to understand why there cannot be a "true volume" indicator in forex trading, why it isn't possible to know how much money goes through the market at any given time. Simply put, the market is just too large and has too many exchanges. For any given forex broker to have a true volume indicator, it would need to have feeds from every bank in the world which exchanges one currency for another, detailing the size of each transaction. This is not practical and probably not possible today. In fact, the only way in which we could have accurate volume information would be if forex was traded in a centralized exchange, something which will likely not happen due to the flexibility independent feeds give to inter-bank negotiations.

But what is that indicator you see on your trading platform ? For example, there is an indicator named "Volume" in Metatrader 4 which displays what appears to be volume information. Is this indicator displaying volume ? How does it calculate it ? The truth is that what the indicator displays is NOT true volume but a simple measure of the number of ticks received for a given time period. For example, a volume of 20 means that during that given time period the platform received 20 ticks.

Is the number of ticks directly proportional to volume ? Yes and no. It does give an idea about the amount of "activity" in the market but it does not give you any idea about the amount of money going through the banks. Since the amount of money is not proportional to the number of ticks. For example if the amount of money exchanged is very large but the number of transactions is small you might have a large candle with a small "volume" (measured as number of ticks) but the real volume would be large. Therefore, the "Volume" indicator is not a true measure of market volume.

Is it completely useless then ? No, as I say, it is a measure of market activity, a measure of the "amount of transaction" more than the "volume of the transactions". It still can be used on some analysis in which knowing market activity is important but it cannot be used to validate patterns and do volume analysis like on the stock and futures markets, simply because it is not the same variable. We could use the volume indicator as a way to determine market volatility and to predict the time of the day in which price will fluctuate to a larger extent, however using this indicator to determine the validity of moves is simply wrong since it does not correspond to true volume and moves which apparently happen on "low volume" may in fact be large volume moves which happen on a few transactions. Therefore, the "Volume" indicator is more like a "liquidity" indicator, allowing us to locate periods where large amounts of buyers and sellers were available.

Another important problem is that since the "Volume" indicator depends on the number of ticks, it is very broker dependant, therefore the building of automated trading systems based on this indicator is bound to give very large broker dependency unless measures are taken to normalize the volume indicator, something which also does not completely guarantee that this problem will be eliminated (although it is bound to be reduced).

If you would like to learn more about what I have learned about automated trading and how you too can reach your long term profitability goals using automated trading systems please consider buying my ebook on automated trading or joining Asirikuy to receive all ebook purchase benefits, weekly updates, check the live accounts I am running with several expert advisors and get in the road towards long term success in the forex market using automated trading systems. I hope you enjoyed the article !

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