Limitations of Using Volume in Forex
While trading volume can be a useful indicator for traders, it is still worth noting that relying heavily on trading volume alone can lead to many costly mistakes.
One of the biggest hurdles is the absence of centralized data. Unlike stocks or futures, the forex market operates in a decentralized manner, which means there isn't a single source that provides the total volume.
Traders often have to depend on tick volume, which tracks price changes instead of the actual size of transactions. Although there's a strong correlation between tick volume and real volume, it's still just an indirect estimate that might not always accurately represent true market activity.
Another notable issue is the divergence in volume data from broker to broker. Since brokers utilize various liquidity providers and trading systems, the tick volume on one platform might look quite different from that on another, resulting in inconsistent readings.
This inconsistency can be especially troublesome for strategies that rely on precise volume levels or comparative analysis.
Additionally, volume spikes can be deceptive in low-liquidity situations, like during news events or outside of major trading hours. A sudden surge in activity might be more about algorithmic responses than actual involvement from significant players. Misreading these signals can lead to hasty entries or exits.
Putting an outsized emphasis on volume can lead traders to overfit their strategies, concentrating on patterns that may not hold up in real market conditions. It is important to view volume as part of a larger toolkit of indicators you can use together in order to reduce the risk of false signals and have access to more reliable data.
Real-World Examples of Volume Use
To better understand how volume can be used in trading, we can look at two practical examples of a EUR/USD breakout strategy and a GBP/JPY divergence to identify how they work and how you can implement them in your trading strategy.
EUR/USD breakout using volume
A trader has noticed that EUR/USD has been stuck in a tight range between 1.0850 and 1.0900 for a few days now.
As the pair edges closer to the upper limit of this range, the trader is on the lookout for a possible breakout. To avoid any false moves, the trader keeps monitoring the volume in the meantime.
When EUR/USD finally breaks above 1.0900, the tick volume on the 1-hour chart spikes to its highest point in several days. The breakout candle closes strongly above the resistance zone, and the volume stays high on the following bar, confirming that there’s real interest in this move.
This surge in volume suggests that institutional players might be getting involved, which boosts the chances of a solid trend forming.
The trader decides to go long at 1.0910, setting a stop-loss just below the breakout point at 1.0885. In the next few hours, EUR/USD keeps climbing, hitting 1.0965, where the trader takes some profits.
In this scenario, volume acted as a crucial filter, helping the trader distinguish between a true breakout and a fleeting spike. Without that volume confirmation, the setup could have seemed risky or uncertain.
Divergence in GBP/JPY
On the 4-hour chart, GBP/JPY has been steadily climbing, creating a series of higher highs and higher lows. As the pair approaches a new local high around 188.20, the trader spots that tick volume has started to drop even though prices are rising.
By adding a volume indicator, the trader uncovers a bearish divergence: while the price keeps climbing, each upward move is met with lower and lower volume. This hints at a weakening momentum and a possible waning of buying interest. Meanwhile, the RSI is creeping into overbought territory, which adds to the concern.
The trader is on the lookout for a confirmation signal. When GBP/JPY forms a bearish engulfing candle on decreasing volume near the peak, the trader sees this as a sign of a potential reversal and decides to enter a short position at 188.00, placing a stop-loss just above the swing high.
In the following two sessions, GBP/JPY drops to 186.30, confirming the divergence setup. In this case, the volume divergence offered an early warning that the bullish trend was losing steam, providing the trader with a low-risk, high-reward opportunity for a reversal.
How to Integrate Volume in Forex Trading
Integrating volume into forex trading can really boost the accuracy of your trade entries and exits, especially when you're looking to confirm trends, breakouts, or reversals.
While the spot forex market doesn’t provide centralized volume data, many traders turn to tick volume from their brokers as a useful stand-in.
As we have already covered, tick volume reflects the number of price changes within a candle, serving as a solid approximation of market activity and liquidity.
The first step in bringing volume into your trading strategy is to choose a dependable volume indicator, like the On-Balance Volume, Volume Price Trend, or even a straightforward tick volume histogram.
Once you’ve added it to your chart, you can start to see how volume interacts with price action.
For instance, if you notice rising volume during an uptrend, it usually confirms strength and ongoing momentum. On the flip side, if prices are climbing but volume is dropping, that could signal potential exhaustion or divergence.
Volume really shines in breakout situations. A breakout that’s backed by high volume indicates strong conviction and likely institutional involvement, whereas a breakout with low volume might not have the necessary follow-through.
Similarly, during reversals, volume divergence, where the price hits a new high or low but volume doesn’t follow, can serve as an early warning sign of a trend change.
Incorporating volume also plays a key role in risk management. For example, entering a trade when volume is high and exiting when it starts to weaken can help you optimize your reward-to-risk ratios.
You can also pair volume analysis with other tools like support and resistance levels, RSI, or Fibonacci retracements for added confirmation.
FAQ on How to Use Volume in Forex Trading
Is volume useful in forex trading?
Despite the absence of centralized volume data, trading volume can be very useful for forex traders. Tick volume is especially useful, as it reflects the number of price changes during a specific period. Volume helps confirm trends, validate breakouts, and/or identify potential reversals. When combined with price action and technical indicators, volume can be useful in improving trade timing and filtering false signals in an otherwise fat-moving market.
How do I make a forex volume trading strategy?
In order to build a forex trading strategy revolving around volume, you can start by choosing a reliable tick volume indicator, such as the OBV or a volume histogram. If you combine volume with price action, you can look for high volume on breakouts or divergence between volume and price to spot potential reversals.
It is important to set clear entry and exit rules based on volume confirmation. If you wish to improve accuracy, you can add supporting tools like the RSI and moving averages to the mix.
What are forex trading volume indicators?
Volume indicators in forex trading are some of the most useful tools in examining trends, reversals, continuations and divergences.
Common volume indicators, such as the OBV, VPT, and A/D, help traders confirm trends and detect breakouts, after which they can identify entry and exit points based on how volume behaves over time. This adds another layer to how forex traders analyze the market.