Crack the Code of Volume Spread Analysis for Smarter Trading

10 Jan 2024
volume spread analysis blog post

When examining the Forex market, the primary focus of many traders is on prices and their fluctuations. Indeed, understanding market trends and timing your trades strategically is essential in the world of trading. However, there are other factors to consider when evaluating the market, apart from just the price. Considering the latest updates in the forex market, it's worth noting that volume can play a significant role in your analysis. When a small group of traders choose to sell a currency, it may not have significant implications. However, if a large number of traders decide to take the same action, it may be worth paying attention to.

 However, volume alone does not provide significant insights. Understanding the actions of market participants is crucial for making sense of Forex news and gaining valuable insights. That is why it can be beneficial to consider both price movements and the corresponding volume when analyzing the market. This analysis can serve as a valuable tool to gain insights into the market's movements and potential future directions.

 Volume Price Analysis or Volume Spread Analysis is a form of analysis that examines both price action and volume. The term "spread" in the latter name refers to the difference between the opening and closing price. This article will refer to the concept of Volume Spread Analysis as vsa forex for convenience.

 The VSA is commonly used with candlestick charts. Other types of charts, like bar, line, or Kagi charts, need to be better-suited for this purpose.

 This article provides an overview of the Volume Spread Analysis, covering fundamental concepts like candlestick chart analysis, trend identification, and supply and resistance levels within the VSA framework.

The Development of the Volume Spread Analysis and Volume Spread Analysis Indicator

VSA builds upon the knowledge imparted by Richard D. Wyckoff, a seasoned stock trader who commenced his trading journey at the tender age of 15 in 1888. During the 1910s, Wyckoff released his weekly predictions that garnered a readership of more than 200,000 subscribers. His correspondence courses can still be accessed today. In addition, Golden Gate University in San Francisco includes the volume spread analysis wyckoff in its curriculum. Wyckoff disagreed with market analysts who relied on chart patterns for their trading strategies. In his view, the application of mechanical or mathematical analysis methods stood little chance against the power of thorough training and seasoned judgment.

Tom Williams, a seasoned stock market trader from the 60s and 70s, built upon volume spread analysis wyckoff. He emphasized the significance of variations in prices (price spreads) in relation to the volume and the closing price. Williams found himself in a one-of-a-kind position that enabled him to create his approach. The findings of his research have been accessible to the public ever since his book "Master the Markets" was published in 1993.

What Is the Reason That Wyckoff Volume Spread Analysis Is Effective?

The fundamental concept of wyckoff volume spread analysis is that individuals can solely generate profits from the financial markets if we grasp the actions undertaken by seasoned traders. Experienced traders are significant participants. They have a considerable presence.

Thus, they make their mark in the vast expanse of data. When experts are in action, the market exhibits significant trading activity. On the other hand, when the market volume is low, the experts may be exercising caution. Therefore, to gain insight into the activities of major players, more than relying on price movements is required.

Does the VSA Function in Every Market?

VSA places its emphasis on the interplay between price movements and trading volume, with the aim of uncovering the strategies employed by seasoned traders. Therefore, as far as a market possesses a team of experts and provides trustworthy information on prices and trading volume, the trading concept of vsa forex remains valid.

Practically every financial market (stocks, futures, forex) is suitable.

Nevertheless, when it comes to the spot forex market, understanding volume can be pretty challenging. You won't receive the actual amount of trading activity. You receive tick volume, which calculates the instances in which the price moves higher or lower. If you plan on utilizing VSA techniques for spot forex trading, it is crucial to determine the reliability of your tick volume source as a proxy for natural volume.

How Can We Execute Trades Using VSA Indicator And Method?

We must admit that mastering VSA can be quite challenging. This is due to the fact that traders have interpreted different VSA concepts in various ways. Becoming proficient in VSA trading necessitates extensive experience and careful monitoring of the market over an extended period of time. Think about the extensive amount of time that Jesse Livermore, Richard Wyckoff, and Tom Williams dedicated to studying the markets. However, there is room for enhancing our trading by grasping fundamental VSA principles that are straightforward to comprehend. 

The Main Ideas Behind VSA Trading

1. Accumulation

Accumulation is the initial step in comprehending volume price analysis. Imagine you're an entrepreneur in the business of selling shaving blades. Let's consider a scenario that highlights the importance of comprehension. In order to boost sales, it is essential to promote the products and highlight their distinct advantages over similar offerings. Feel free to utilize a wide range of marketing concepts at your disposal.

Prior to proceeding, it is imperative to verify that you possess an ample quantity of merchandise to offer for sale. Failure to do so will result in the campaign falling short of its intended objective. This is commonly referred to as a place in the marketing mix.

In Volume Spread Analysis (VSA), this phenomenon is referred to as accumulation, where insiders gradually stockpile their assets, thereby boosting their ownership. With the insiders making purchases, the value of the assets, including shares, is expected to keep declining.

The media is a powerful tool that those in the know use to persuade asset owners to sell their holdings. During the accumulation phase, the price experiences a decline while the volume shows an upward trend.

2. Distribution

After accomplishing their objective of lowering the price and acquiring more shares, the insiders are now entering the distribution phase.

At this point, with the insiders already in possession of the assets, they begin to drive the market upwards. Once more, the media has a significant impact in exaggerating the assets possessed by those on the inside. As a result, the assets that experienced a substantial decrease in price are now beginning to increase.

The ascent commences swiftly before transitioning into a more gradual pace as those with privileged information strategize their subsequent moves.

3. Supply Testing

The insiders have now wholly cleared out their stores. For regular individuals, they would begin the initial phase of gathering and amassing. Incorrect! The insiders possess greater wisdom in that regard. Prior to returning to the initial phase, they evaluate the market.

They conduct tests to avoid the risk of encountering a fresh surge of selling by retail investors after making purchases. They have no desire for that. During testing, insiders initiate a small-scale selling strategy by offloading limited quantities of the assets in order to stimulate demand and drive up the price.

4. Assessing market interest

If the supply test proceeds according to the insiders' expectations, the subsequent step involves assessing the demand. At this point, the insiders are not interested in launching a campaign to stock up their warehouses and return to an area with high demand, as this would only cause the market to move in the opposite direction. In order to prevent this scenario, they implement a trial run.

This test is designed to confirm that the pressure from demand has been effectively managed during the distribution phase. Furthermore, during this stage, those with insider knowledge have successfully transitioned the price from its initial wholesale value to its desired retail price. Once this examination of demand concludes, a fresh surge of sales commences, driving the price downwards.

5. The Climax of Selling

During the initial phase, retail investors are selling while insiders are making purchases. The insiders refer to the prominent investors and hedge funds who possess extensive knowledge about the company. They collaborate closely with their investment bankers.

Although insider vsa trading is considered a criminal offense, retail investors have been misled into believing that it is non-existent. It is evident that the practice of insider trading, where investment banks and company executives disclose information to their clients, is still prevalent.

VSA Patterns

1. Shooting star

shooting star

The volume spread analysis indicator suggests a lack of strength.

The shooting star pattern is created when a candle has a slim body and a minimal or nonexistent lower wick but a significant upper wick. This is what it looks like:

It's evident that the appearance closely resembles the upper wick. To remind you, it happens when buyers try to push prices up during the session (or whatever timeframe you have chosen for your chart), but sellers overtake the market and bring prices back down. That's the reason why the pattern suggests a lack of strength in the market—it indicates that bears triumphed over bulls.

It's crucial to keep in mind that this chart pattern does not necessarily indicate that prices will immediately start trending downward. It only shows a weakness in the market. In order to grasp the magnitude of the weakness and anticipate future price movements, it is essential to carry out the steps above. It is critical to observe if there are any additional shooting star candles present on the chart, their position within the trend, and the corresponding volume levels.

If a solitary shooting star emerges during an upward trend, it is likely to result in a modest retracement, at most. Each successive shooting star indicates a growing fragility in the market. If there is an increase in volume, it suggests a higher probability of a more significant correction or even a complete reversal. If numerous shooting stars with a substantial volume emerge on a horizontal chart, anticipate a downward breakout. The more prices remained stagnant, the more pronounced the eventual downward trend is expected to be.

For your convenience in grasping the mechanics of this process, behold a chart showcasing a myriad of potential iterations of a shooting star pattern that may manifest amidst a prevailing trend:

shooting star pattern

2. Hammer

hammer pattern

The pattern suggests a strong presence.

The hammer candlestick pattern can be seen as the complete opposite of the shooting star pattern. It develops when a candle possesses a remarkably slim body accompanied by an exceptionally elongated lower wick and an exceedingly brief or completely nonexistent upper wick. This is what it looks like:

The process of creating the hammer pattern is akin to that of forming the lower wick. Sellers attempt to drive prices down, but buyers step in to seize control of the market and cause prices to bounce back. In the event of a shorter lower wick on a typical candle, prices have the potential to fluctuate following the formation of the wick. However, a candle exhibiting the hammer pattern indicates that bulls maintained dominance by the conclusion of the session. This indicates a positive sentiment and a robust market.

It's important to keep in mind the key steps mentioned earlier when analyzing the chart with Volume Spread Analysis. Take note of any comparable patterns on the adjacent candles, pay attention to the volume, and consider the position of the pattern within the overall trend.

On its own, the pattern indicates a sense of resilience, yet it fails to convey the true magnitude and duration of its impact. A solitary hammer candlestick accompanied by a meager trading volume amidst a robust downward trend suggests a mere temporary rebound before prices continue their descent. If it occurred soon after the accumulation phase, it is likely a positive supply test. A hammer indicating a moderate increase implies a significant upward correction. A hammer with a loud sound suggests a possible significant pause or even the conclusion of the downtrend.

Check out this image showcasing various instances of the hammer pattern on a chart:

hammer patter graph

3. Long-Legged Doji

The pattern suggests a need for more clarity.

The appearance of a long-legged doji pattern bears a resemblance to a fusion of the shooting star and hammer candles. A long-legged doji candlestick features a highly slender body, accompanied by elongated wicks on both the upper and lower ends, hence the name "long-legged." Here's a demonstration of what it might look like:

long-legged doji

The pattern indicates that the market sentiment is not leaning toward either bullish or bearish. The elongated-legged doji suggests that the market is highly unpredictable, with both buyers and sellers grappling to gain control. They continuously exchange the price, yet neither manages to establish a firm hold on the market in the end. Typically, this pattern leads to the conclusion of the trend or a complete turnaround as long as it is confirmed.

It's crucial to understand that, based on the Volume Spread Analysis, the long-legged doji pattern may encounter irregularities. Under typical conditions, market volatility indicates a significant level of activity and, consequently, either high or, at the very least, above-average volume. If that's true, the confirmation of the long-legged doji pattern can be acknowledged. However, if there is a noticeable pattern indicating market volatility, but the trading volume is minimal, it suggests an irregularity.

long-legged doji pattern

Supporters of the vsa forex offer the following explanation for why these irregularities occur: individuals with insider knowledge are attempting to activate stop orders that retail traders have set. In this scenario, market makers manipulate prices by constantly fluctuating them, often utilizing news as a catalyst for significant movements. By adopting this approach, insiders can effectively eliminate undesirable influence from retail traders and establish their dominance over the market.

According to VSA experts, it is advisable to steer clear of the market when you come across a long-legged doji candle accompanied by low trading volume. If the candlestick is accompanied by significant trading volume, indicating active participation from market makers, it is essential to be prepared to identify and follow the emerging trend. The reasoning behind such guidance is that the involvement of individuals with insider knowledge suggests that the trend is authentic and not a deceptive ploy.

4. Narrow-spread candles

The trend suggests a lackluster market sentiment.

Although it is not typically included in candlestick patterns, the Volume Spread Analysis takes a unique perspective on candles that have a small range and brief wicks. Typically, these candles appear when traders lack a strong sentiment toward the market and anticipate news or data to drive the market in a particular direction. Typically, these candles hold little appeal for traders. However, the VSA users have a keen interest in these candles as they seek out irregularities in volume.

What defines an irregularity on a candlestick with a small range? Firstly, let's consider the ideal criteria for validating these candles. Candles with a small range typically indicate a tranquil market and minimal activity. As a result, the volume of these candles needs to be low as well. That's the reason why candles with a slight difference between the opening and closing prices and low trading volume can be seen as confirmed. As a result, candles with little difference between the opening and closing prices and higher-than-average trading volume can be seen as an unusual occurrence.

irregularity on a candlestick

irregularity on a candlestick above

However, what could this peculiar occurrence possibly signify? Supporters of the VSA theory argue that it indicates a diminishing grip of insiders on the market. They are actively engaging in the market, making efforts to steer it towards their desired outcome. However, the other traders prevent that from occurring, pushing it in the opposite direction.

But what insights can we glean regarding the future direction of the market? As per the VSA, this indicates an imminent reversal. If the tight-range candle was bullish, the irregularity suggests that the market resisted a higher price and is likely to decline. On the other hand, if the candle had a negative trend, the unusual occurrence indicates that the market is not inclined to see prices fall and is likely to experience a rally soon.

Nevertheless, VSA experts advise against taking immediate action upon identifying a candle with a small spread. It is recommended to wait for additional indications of reversals, such as patterns like a shooting star, a hammer, or a long-legged doji.

5. Wide-spread candles

The trend suggested a robust market outlook.

This pattern is straightforward: the candle's body has a broad range, while the wicks are extremely short or nonexistent. The market remained relatively stable throughout the session, with minimal fluctuations in its movement. This behavior indicates a significant sentiment towards the close: favorable if costs close above the initial level and bearish if they close below.

The VSA experts strongly recommend analyzing the trading volume prior to entering the market. If the trading volume is higher than usual, it is believed that insiders are actively involved in the market. In such cases, it is safe to open a position based on the overall market sentiment. However, according to VSA followers, a low volume suggests that the movement may need to be more authentic, and they advise caution in participating in the market.

6. Hanging man

The pattern suggests a possible vulnerability in an upward trend.

The hanging man pattern bears a striking resemblance to the hammer pattern — a candle with a slender body, an extremely short or non-existent upper wick, and an exceptionally elongated lower wick. The distinction between the two patterns lies in their positioning within a trend. Although the hammer pattern has the potential to show up in various parts of a trend, the hanging man pattern exclusively emerges at the peak of an uptrend. It can be pretty challenging to identify a dependent man, as it can easily be mistaken for a hammer, even though these two patterns have opposite implications for the trend. The volume must exceed the norm.

hanging man pattern

However, the narrative conveyed by the hanging man pattern diverges significantly from that of the hammer pattern. Why does it indicate a lack of strength despite the bulls dominating the market at the session's conclusion? According to the Volume Spread Analysis, the following explanation is provided: those with insider knowledge cautiously assess the situation prior to commencing the distribution phase. Based on the VSA theory, the hanging man pattern indicates that market makers are evaluating if the market can handle their selling. The significant level of trading activity shows that market participants are actively engaged in the market. The observation that prices rebounded following a decline caused by insiders indicates the presence of a sufficient number of buyers interested in purchasing assets being offered by specialists. And that suggests to those in the know that now is a prime opportunity to begin offloading.

According to VSA experts, it is recommended to wait for confirmation of the weakness once a hanging man candle is identified. In an ideal scenario, the hanging man candle should be promptly succeeded by a shooting star candle. This indicates a strong validation signal and suggests that a reversal is highly probable in the near future. However, should a shooting star make its appearance at a later time, it remains a sign of validation. Validation can only occur if the hanging man candle is accompanied by higher-than-average volume.

A Number Of Useful Observations

We suggest exploring intriguing resources on the Wyckoff method and also delving into the book "Master the Markets" by Tom Williams and take a closer look at the volume spread analysis indicator.

The VSA technique may not be perceived as a comprehensive solution to all problems, as its logic and recommendations may only partially consider fundamental vsa analysis. The trader must evaluate a situation overall before determining if the VSA pattern can be a profitable option. Need an illustration? Each month, there is a buzz leading up to the release of Non-Farm Employment Change data, and typically, there is a speculative response across various trading assets following its publication. Patterns formed on similar news can often be misleading, and even days later, the market may still experience speculative reverberations.

Volume spread analysis indicator may not always be precise for determining the ideal position to open. However, they do offer valuable insights into the asset's volatility and the relative volume at any given time. A sudden shift in the volume dynamics will alert the trader to the influx of a substantial amount of funds into the market. Their objective is to decipher the implications of this development accurately. Market participants typically wait to enter the market with a large volume at a single price. Instead, they gradually build up their position and distribute their interest within a narrow price range. As a result, employing a scalping VSA technique may be challenging.

None of the versions provide clear signal descriptions, and at times, the vsa indicator produces completely illogical signals, particularly when the preceding candle has a significant "body." Although it goes against the trader's logic, the can be seamlessly incorporated into any trading strategy as a tool to weed out false signals. Additionally, it can significantly enhance vsa analysis when combined with Fibonacci and oscillators.

At times, the pattern on the histogram of the VSA forex indicator surpasses the typical stochastics, particularly prior to the conclusion of a trend or the onset of a correction. A green or red bar catches the trader's eye and directs their focus to the present circumstances. Nevertheless, it is crucial to prioritize trade decisions based on the typical signal. For instance, if a white bar materializes, it is advisable to wait for the trend line to be breached before entering the market. Additionally, it is prudent to wait for a retest of the support/resistance line.

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