Volume-Based Trading: A Very Useful Indicator for Traders

In the world of trading, volume is often the most overlooked yet powerful indicator. While price tends to steal the spotlight, volume acts as the undercurrent that validates price movements. It provides support, confidence, and confirmation — essentially serving as the backbone of market momentum. 

Volume in financial markets refers to the number of times a security is traded over a given period. Volume-based trading involves analyzing this raw volume data directly or through specific indicators to identify and execute trades with a higher probability of success. 

Reading Volume: The Foundation 

Understanding volume is just as critical as analyzing price. Sharp price moves backed by high volume often signal the strength of the trend. 

Here's how volume confirms price action: 

• Price rises + increasing volume = Bullish confirmation 

• Price falls + increasing volume = Bearish confirmation 

In broader terms, volume supports market sentiment. For example: 

• An uptrend with rising volume, followed by a pullback with lower volume, reinforces a bullish setup 

• A downtrend with rising volume, followed by a weak bounce with lower volume, confirms bearish strength 

• Breakouts or breakdowns accompanied by surging volume tend to be more reliable and sustainable 

Indicator-Based Volume Trading 

While raw volume data can be powerful, many traders prefer indicators that help interpret it visually and quantitatively. Below are some of the most widely used volume-based technical indicators: 

1. On-Balance Volume (OBV) 

Developed by Joseph Granville, OBV is a cumulative volume indicator. The logic is simple: 

• If today’s close is higher than the previous, the day’s volume is added 

• If today’s close is lower, the volume is subtracted 

OBV is mainly used to identify divergences between price and volume, which often signal institutional activity: 

• Price makes higher highs + OBV does not → Bearish divergence 

• Price makes lower lows + OBV makes higher lows → Bullish divergence 

These divergences suggest a disconnect between price and volume — a potential sign of accumulation or distribution before a major move. 

2. Accumulation/Distribution Line (ADL) 

Developed by Marc Chaikin, the ADL measures money flow into or out of an asset. It uses a money flow multiplier calculated from price and volume, which fluctuates between +1 and -1 depending on where the price closes within its daily range. 

Key signals from ADL: 

• Positive ADL trend + rising price → Buying pressure 

• Negative ADL trend + rising price → Bearish divergence (possible reversal) 

• Positive ADL trend + falling price → Bullish divergence (potential recovery) 

The ADL helps traders see if volume supports price or if the move lacks real conviction. 

3. Money Flow Index (MFI) 

Developed by Gene Quong and Avrum Soudack, the MFI combines price and volume, making it a volume-weighted RSI. It ranges between 0 and 100: 

• Above 80 → Overbought 

• Below 20 → Oversold 

It uses a typical price (average of high, low, and close) multiplied by volume to calculate money flow. MFI identifies: 

• Overbought/Oversold conditions 

• Divergences with price, which can suggest trend reversals 

It’s ideal for traders looking to spot volume-backed exhaustion points in market trends. 

4. Chaikin Money Flow (CMF) 

Also by Marc Chaikin, CMF is different from ADL as it is not cumulative. Instead, it calculates money flow over a fixed period (usually 20 or 21 days). 

Key characteristics: 

• Oscillates between -1 and +1 

• Typically moves between -0.50 and +0.50 

• Above 0 = Buying pressure 

• Below 0 = Selling pressure 

Like OBV and ADL, divergences between price and CMF can reveal hidden accumulation or distribution patterns. 

5. Volume Oscillator (VO) 

VO operates like a MACD, but it’s calculated using volume instead of price. It subtracts a slow EMA of volume from a fast EMA, and the result is shown as a percentage of the slow EMA. 

Use cases: 

• Ideal for spotting breakouts or breakdowns 

• Helps detect volume expansion or contraction 

• VO above zero = Strong volume 

• VO below zero = Weak volume 

However, VO should always be interpreted alongside price movements to confirm a trade setup. 

Conclusion 

Volume is a core pillar of technical analysis, yet many traders overlook its importance. While interpreting raw volume data may feel complex, volume-based indicators simplify the process and provide actionable insights. 

However, these indicators are not standalone signals. They should always be confirmed with price action to avoid false signals, especially since volume indicators may lag in certain scenarios. For traders looking to strengthen their strategy, incorporating volume can offer a crucial edge in timing and confirmation.