Volume spread analysis
Introduction
Volume spread analysis (VSA) is a method of technical analysis which examines the relationship between the price, spread or range, and volume. This technique is used in various markets such as stock, commodity, and forex. VSA is not a standalone method and is often combined with other forms of analysis to make informed trading decisions.
History
The concept of volume spread analysis was originated by Richard Wyckoff, a prominent 20th-century stock trader and market analyst. Wyckoff's work was later developed and extended by Tom Williams, a former syndicate trader, who coined the term "Volume Spread Analysis".
Principles
The fundamental principle of volume spread analysis is that the market is driven by supply and demand. It assumes that changes in supply and demand are reflected in volume and price – and that these changes can be identified and exploited for trading advantage.
Elements of Volume Spread Analysis
Volume spread analysis involves three key elements: volume, spread, and closing price.
Volume
In VSA, volume is considered the major indicator of a market's future direction. It represents the total amount of trading activity or contracts traded during a given period.
Spread
Spread refers to the difference between the high and low prices of a security during a specific period. In VSA, the spread is used to gauge the market's strength or weakness.
Closing Price
The closing price is the final price at which a security is traded during a given trading period. In VSA, the closing price is used to determine the market's sentiment.
Methodology
Volume spread analysis involves a series of steps to identify potential trading opportunities.
1. Identify the prevailing trend: The first step in VSA is to identify the prevailing market trend. This can be done using trend lines, moving averages, or other trend identification techniques.
2. Analyze volume and spread: The next step is to analyze the volume and spread of each price bar. This involves looking at the size of the spread and the volume on up bars and down bars.
3. Look for signs of strength or weakness: The third step is to look for signs of strength or weakness in the market. This involves looking for high volume up bars at key market levels, which indicate strength, and high volume down bars, which indicate weakness.
4. Confirm with the closing price: The final step is to confirm the analysis with the closing price. If the closing price is near the high of the bar on a high volume up bar, this confirms strength. If the closing price is near the low of the bar on a high volume down bar, this confirms weakness.
Applications
Volume spread analysis can be used in various ways in trading. Some traders use it to identify the start of new trends, while others use it to spot potential reversals. It can also be used to confirm signals from other technical analysis methods.
Limitations
While volume spread analysis can be a powerful tool in trading, it also has its limitations. One of the main limitations is that it relies on accurate volume data, which is not always available in all markets. Furthermore, VSA is a subjective method of analysis, meaning that it can be interpreted differently by different traders.