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Reader question: Volume?

Nathan asks:

Does volume play any role in your analysis? Do you look at increased volatility in conjunction with increased volume? Also, since the spot FX market does not have any volume, does the volume in the futures FX carry any significance?

[dc]G[/dc]ood question, Nathan. Short answer is no, I don’t use volume in my analysis or trading in any way. The reason is simply that I have been unable to verify a statistical edge to volume, with a few exceptions. (For instance, it appears that equity indexes making new highs on dramatically lower volume is a slightly bearish sign, even when adjusted for seasonality of volume.) I am obsessive about only using things that I can show have an actual edge, and this means that many of the traditional tools of technical analysis… well, I don’t use ’em. Moving averages? Nope. Statistically speaking, there is no edge to a market touching any moving average. Fibonacci ratios? Covered that one here and here. Volume? Negative. Candlestick patterns? Pretty names. I could go on (and, in my trading course, I have gone on and on) about what doesn’t work, but I think there are more important points.

121313_1953_ReaderQuest1.jpgThe first, and, truly, probably the most important thing I have to say to anyone who has anything at risk in financial markets: be sure that what you are doing actually works. Everything is testable and quantifiable, and there is no good reason to not understand your edge. Don’t accept anything at face value because it is in a book, a trading course, a curriculum for a test, etc. It is your money, your time, your emotional capital, and a piece of your life at risk–is it not worth your time–no, is it not your responsibility–to make sure that what you are doing actually works? (And how much more so if you manage client money and risk!)

How would you test volume? Well, one simple way is to take a pattern that has a positive expectancy, and then separate them by those that have good volume support and those that don’t. Compare stats for the two, and does the set with volume support show that it is better in some way? Higher return, lower variance, higher win rate, or some other statistic? It is so easy to find books that explain why volume is critical (and it is completely logical that volume would be critical), but what do the numbers say? (As an interesting aside, Bulkowski actually did this work in one of the later editions of his book, and was surprised to find that volume did not add an edge to the patterns he was examining.) Volume is pretty tightly correlated to range and some measures of volatility, so you risk adding a highly correlated input to a trading system if it is already based on chart patterns, and highly correlated inputs are never a good thing.


Adam Grimes has over two decades of experience in the industry as a trader, analyst and system developer. The author of a best-selling trading book, he has traded for his own account, for a top prop firm, and spent several years at the New York Mercantile Exchange. He focuses on the intersection of quantitative analysis and discretionary trading, and has a talent for teaching and helping traders find their own way in the market.
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