The price is not the only weighty factor to be considered while analyzing Forex market. Besides the currency exchange rate, its trading volume plays an important role, too.
There is the postulate of the Dow Theory that tells that the trend must be confirmed by the trading volume. Unfortunately, Forex does not let us evaluate the cash equivalent of its trading volume at a specific time frame. As the currency exchange has no definite place where the trades are carried out, the currency is exchanged throughout the world by the banking network. That means nobody can count the total cash flows in those international trades. For an approximate calculation one could, perhaps, use the data of currency futures trading volumes, because the futures market in regard to such contracts has a strong correlation with Forex market. But to get even an approximate idea of Forex cash volume, it would be necessary to consider a whole batch of futures markets existing in the world. And that seems impossible, too. That’s why one uses other approach to evaluate the trading volume on the currency exchange.
Indeed, one should not consider Forex trading volume to make a decision, whether to open or to close a position, because it is not quite correctly. In this case several big banks, comprising billions of funds, could create a semblance of the interest in any currency. It’s helpful to analyze not the cash volumes, but the amount of trades made during the trading period under examination. For the approximate evaluation of that indicator the number of quotes made by market maker is used. As usual, only changed quotes are set under consideration out of all the amount of the quotes remaining untouched. The faster the price varies, the more the market interest in supporting current trend is confirmed.
Thus, instead of trading volume, we take the rate of quotations change of the market maker as an appropriate tool in technical analysis on a certain time frame. The trading volume is the second most significant indicator (after the price), that trader analyzes accurately. Analyzing the trading volume one plots a specific chart - trading volume histogram, where the values are represented in bars of various heights. Each of the bars corresponds to its timeframe, according to the chosen scale (1 min, 5 min, 15 min, and so on). The height of a bar is determined by the value the trading volume, the higher the bar is, the faster is the rate of market-maker quotations change. Histograms, as usual, are inserted at the bottom of the price charts. In this case every bar of the histogram complies with one of the chart’s shape (bar or candlestick) and sets the volume of trades made over a certain period of time represented by that shape.
Trading volume histograms do not comprise the information about activity of “bulls” and “bears”, i.e. the diagram doesn’t let us understand what kind of operation prevailed during the trading period: bullish or bearish. But such information is excessive, because the market favor could be easily discerned by a price chart. It is necessary to notice that the trading volume, as a rule, is ahead of the price movements as the quotes are more inert compared to the volume indicators. If the price growth happens at the increasing trade volumes, and then if the volume sheds, the price still climbs for a while, and only after it drops down. Thus, any changes in trading volumes could be a good sign for the ease or turn of the market trend, and we should never disregard this while testing the currency market.
Always make the histograms of trading volumes underneath the price charts while you analyze Forex! The daily and weekly volumes are the most important ones for the analysis.
The third important figure in technical analysis of a currency market (after price and volume) is an open interest, otherwise, an unclosed contracts volume at the end of a trading period. It is not an absolute value of this figure that has any significance, but its fluctuation: up or down motion.
The growth of the trading interest could serve as a good indicator for the long-term preferences. If a position keeps being unclosed, it means that the trader supports an existing trend for the long future. But superfluous extension of the trading interest can be a sign of the market turnaround, as traders are going to close their positions fixing the profit. The open interest diagram is placed, as usual, between the trading volume histogram and the price chart. But this diagram is not used on Forex. As Forex trading has no any specific place for trade, it is impossible to fix the open interest volume.
In the summary of this chapter we shall again pay attention onto the postulate of the Dow Theory: the volumes must prove the trend. By the growing or descending trend the price movement often occurs along the direction of the main trend at the growing trade volumes, and the price cross movement occurs during decreasing volumes. You should always draw a trading volume histogram next to the price chart bottom when you analyze or forecast your future speculations on Forex.
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