part0017

As we come towards the end of this book on volume and price, I wanted to pass on some thoughts, observations, advice and comments based on my twenty years of experience, using volume as my predominant indicator. As I have said before, I was lucky to start my trading education and journey with volume. It saved me a huge amount of wasted time and has made me substantial sums over the years from both trading and investing. Many aspiring traders spend years trying systems and methods which never work, and result in them losing confidence, to say nothing of their financial losses. Most then simply give up.

Eventually some of these traders and investors stumble upon volume. Some buy into the methodology instantly, just as I did. Others do not, and if you are in this latter group, I hope I have at least made the case for VPA in this book. However, if you decide VPA is not for you, then you have lost nothing, other than the few dollars this book has cost. If you do decide VPA is logical and makes perfect sense, then I'm delighted, as a lifetime of trading and investing success awaits. Provided you follow the principles I have explained here.

Now, let me introduce some further analytical techniques I use in my own trading and investing, which when combined with the basics of VPA, will help to develop your trading skills with volume as the foundation.

The first technique is price pattern recognition, which we covered when we considered the importance of price congestion. However, I want to revisit it here, and look at some actual market examples. At the same time I would also like to include other key patterns that play an important role in breakouts and reversals, all of which ties into Volume Price Analysis.

The reason for revisiting price pattern recognition is that in the previous chapter I was very conscious of keeping the focus on the volume price relationship, and less so on the broader price behaviour on the chart. My rationale throughout the book has been to explain VPA in stages, and this is another layer we can now add to our knowledge of VPA.

The market chart examples in this chapter will focus entirely on market congestion and subsequent reversals and breakouts, which I hope will cement this aspect of price behaviour firmly in your mind.

The first is a lovely example from the forex market and is from the 15 minute chart for cable (GBP\USD).

The chart in Fig 11.10 really explains all we need to know about price congestion and how it relates to the volume breakout when it arrives. As we can see the chart covers an extensive period with over seventy candles in this phase.

If we start at the left of the chart, the initial entry into the congestion phase is marked by a pivot low which gives us the floor of our price congestion, and two bars later a pivot high is posted with above average volume. The GBP/USD is weak and not ready to move higher with the pair then falling on declining volume, so weakness, but not a trend that will be sustained. And the reason should now be obvious - falling prices and falling volumes. Volumes then decline in general moving between buying and selling, and as the market moves sideways in the congestion phase, we see two further pivot highs posted, followed by a pivot low.

These are followed by a whole series of pivots, both at the ceiling and the floor of the congestion, and as I explained earlier when we were examining this concept, you do have to think of these levels as rubber bands and not as rods of steel.

We can see in this example the pivot points (the up and down arrows), are not all in a straight line. The market is not linear and technical analysis is an art and not a science, which is why volume software that attempts to predict changes in trend can be unreliable. This analysis has to be done manually.

At this stage, as the price continues to trade within the congestion, we are waiting for the catalyst, which will be the signal for any breakout. And on this occasion was provided by an item of economic data in the UK. From memory I believe it was the RPI release. However, the actual release is unimportant. What is important is the reaction on the price chart. The price and volume relationship in the congestion phase once again reinforces the basic concepts of VPA. Here we expect to see low volumes - the insiders are not participating, and coupled with narrow spread price action, simply reinforces this fact. This is the classic relationship ahead of news. Everyone is waiting on the sidelines and 'sitting on their hands'.

And so to the release itself. First, we have a breakout which moves firmly through our ceiling of resistance, which has now become...... support. And if you remember what I said in the chapter on breakouts – we must wait for a clear close well above the congestion phase, and the first candle here delivered this for us. A nice wide spread up candle. Second, we have to check this is a valid move, and the good news is the breakout has been validated by the volume.

As this has been an extensive area of price congestion, any break away will require substantial effort which is what we have here with buyers and insiders taking the market firmly higher. Can we join the move here? This is what we have been waiting for. We have a market that has been in congestion, waiting, and gathering itself, when finally the catalyst arrives and the market moves on high volume.

Furthermore, we now have a deep area of natural price protection in place below, and our stop loss would be below the level of the last pivot low. Time has also played its part here, with cause and effect coming into play. Remember, this is a 15 minute chart, so an extended phase of consolidation and congestion, and therefore any consequent effect should reflect the time taken in building the cause. In other words, the trend, when it breaks, should last for some time. We just have to be patient, and wait.

Finally, there is one further aspect to the breakout, which again I mentioned in an earlier chapter and it is this – the volume has validated the news. The market makers have confirmed the data is good news for the UK pound, and the market has responded. Volumes pick up once again as the market moves higher and away from the congestion phase, and to return to my salmon analogy, another trend has been spawned.

This is the power of the congestion phase – it is the spawning ground of trends and reversals. In this case the ceiling was breached, but it could equally have been the floor. The direction is irrelevant. All we wait for is confirmation of the breakout, validated with volume, and then trade accordingly.

The second example in Fig 11.11 is once again taken from the GBP/USD. This time we are looking at the hourly chart over a period of approximately 4 days in total.

Once again let me explain the highlights and key points. As we can see the pair has been rising, but then the market moves lower as shown by a wide spread down candle. This is followed by a narrow spread down candle with above average volume, and signalling possible buying on this reversal lower. The market pushes higher on the next candle, a wide spread up bar, and posts a pivot low as shown with the small arrow annotated 'Pivot low'. We are now looking for a possible pivot high which will start to define a potential period of congestion.

This duly arrives two bars later, and the pivot high is now in place. Now we are watching for a potential congestion phase, and further pivots to define the trading range. However, on this occasion, the next candle breaks higher and moves firmly away from this area. The potential congestion phase we were expecting has not materialized, so we know this was simply a minor pause in the trend higher, as the pair move up on good volume.

Two candles later, another pivot high is formed, and once again we are now looking for our pivot low to form and define our levels of any congestion phase. In this example the pair do indeed move into congestion, with low volume, and on each rally a pivot high is posted which gives us a nicely defined ceiling. However, there are no pivots defining the floor. Does this matter?

And this is the reason I wanted to highlight this example to make the point, that in fact it doesn't.

A pivot is a unique combination of three candles which then create the pivot, and this helps to define the region for us visually. Pivots also help to give us our 'roadmap' signals of where we are in the price journey. But, sometimes one or other does not arrive, and we have to rely on our eyes to define these levels. After all, a pivot is simply an indicator to make it easier for us to see these signals. In this case the pivot high forms, but there is no corresponding pivot low, so we are looking for a 'floor' to form.

After four candles, the market moves higher again and posts a second pivot high, so we have our ceiling well defined, and this is now resistance. The next phase lower made up of three candles then stops at the same price level, before reversing higher again. We know this pair is not going to fall far anyway, as we have a falling market and falling volume. Our floor of support is now well defined by the price action, and it is clear from the associated volume, we are in a congestion phase at this level. And, my point is this.

When using any analytical method in technical analysis, we always have to apply a degree of leeway and common sense. Whenever a market moves into a region of price congestion, it will not always develop the perfect combinations of pivot highs and pivot lows, and we then have to apply common sense as here, bolstered, of course, by our volume. At the start of this congestion phase, we have a very good idea we are entering a congestion phase, simply from an assessment of the volume. The volume is all well below average (the dotted line) therefore we already know we are in a congestion phase, and the pivots are merely aids, to help define the price region for us.

Therefore whilst pivots are very important it is the volume which will also help to define the start of a congestion phase, and the pivot highs and lows are there to help to define the floors and ceilings of the trading range. If one or other is missing, we simply revert to using our eyes and common sense.

The analogy I use here is when sailing. When we are sailing our boat, we have two forms of navigation. A GPS plotter which does all the work for us which is nice and easy, and the old fashioned way using a map, compass, time, tides and way points. In order to pass the exams and charter a yacht, you have to learn both. And the reason for this is very simple. If there is a loss of power on board, you have to be able to navigate using a paper based chart. The same principle applies here.

We can define where we are by using volume and price visually from the price action on the chart. The pivots are simply there as a quick visual guide, to help identify these price combinations quickly and easily.

Returning to our example in Fig 11.11, we now have the floor defined by our price action and the ceiling defined by our pivot highs. We are now waiting for a signal, and it duly arrives in the form of a hanging man, one of the candles we have not seen in earlier examples, and suddenly the volume has jumped higher and is well above average. The market breaks lower and through the floor of our congestion phase with a wide spread down candle. We now know that, on this occasion, the price congestion phase has been developing into a trend reversal, and is not a continuation of the existing trend.

It is here we would be looking to take a short position. The market pauses and reverses higher, but the volume is falling, and in addition we see a second hanging man candle, suggesting more weakness in the market. We also have the comfort of knowing above us we have one of our invisible barriers of price congestion.

What was the floor of support, has now become the ceiling of price resistance as the market attempts to recover, and this is why congestion zones are so significant to us as traders. Not only do they spawn the trend reversals and breakouts, but they also give us our natural barriers of protection which have been created by the market. Where better to place any stop loss than on the opposite side of a congestion region?

The resistance region holds, and the market sells off sharply with a beautiful price waterfall. However, as the bearish trend develops, so the volumes are falling away, and we know as VPA traders this trend is not going too far. And sure enough, after seven hours of downwards movement, it bottoms out and moves into….......another congestion phase at a different price level.

Ironically, here too, we have a phase which is once again marked by pivot highs, but no pivot lows. However, the volume and price action tell us exactly where we are in the price journey. We simply wait for the next phase to start, which it does, several hours later. Again, how do we know? Volume gives us the answer. The breakout has been associated with above average volume, which is what we expect to see, and off we go again.

I hope from this example, which spans a period of four days or so, you can begin to see how everything comes together. I did not particularly select this example, but it does highlight several key points which reinforce and cement the concepts outlined in earlier chapters.

Reading a chart in this way is not difficult. Every market moves in similar patterns and waves. They trend for a little, then consolidate in a congestion phase, continue the trend or reverse completely. If you understand the power of VPA and combine it with a knowledge of price congestion, then you are 90% of the way there. The rest is practice, practice and more practice, and it will come.

Furthermore, you will then realise the power this gives you in your own trading and investing and how it can deliver financial independence to you and your family. It does takes a little effort, but the rewards are high, and if you are prepared to study and learn, ultimately you will enjoy the thrill of being able to forecast market price action, before it happens, and profit accordingly.

I would now like to revisit a very important concept, I touched on earlier in the book. It is a cornerstone of my approach to trading. Again, it is not unique and can be applied to any market and any instrument, and as always any timeframe. Neither is it unique to VPA. What this concept does do, is give you that three dimensional view of price behaviour, as opposed to the more conventional one dimensional approach most traders take. The principle advantage of this concept is it allows us to assess and quantify the risk on a trade.

This concept involves using multiple time frames to analyse price and volume. It allows us to qualify and quantify the risk of any trade, and assess the relative strength or weakness of any trade, and so its likely duration. In other words, multiple time frames will reveal the dominant trend and primary bias of the instrument under consideration.

Fig 11.12 represents our three time frames. Despite its size we can see both price and volume and this method of analysis is something I teach in my online and offline seminars.

What we have in Fig 11.12 are three charts for cable (GBP/USD). The chart at the top of the image is the 30 minute and is what I often refer to as our ‘benchmark’ chart. In this trio it is this chart which gives us our bias, and is the one against which we relate the other two. Bottom right is the 15 minute, and the chart at bottom left is the 5 minute. All the charts are taken from one of my favourite platforms for spot forex, namely MT5.

The candle I have highlighted on the 30 minute chart is a shooting star, with ultra high volume, sending a clear signal of weakness at this level. The shooting star was preceded by a narrow spread candle also with ultra high volume, and which gave us our initial signal. But how does this appear on our faster time frames? On the 15 minute chart the shooting star is two candles, and on our 5 minute chart it is six candles. I have annotated the chart with the box on each to show you the associated price action.

The reason I use three charts is very simple. My primary trading chart is the 'middle' time frame of the three. In this example it is the 15 minute chart, but using the MT5 chart settings we might equally have a 30 minute, 60 minute and 240 minute chart, or indeed any of those available. In this trio our primary trading chart would be the 60 minute. However, in this example we are using a 5, 15, 30 minute combination, so the primary or trading chart is our 15 minute.

The 30 minute chart is there as our slower time frame, our dominant or benchmark time frame, which tells us where we are in the slower time frame trend. Imagine we are looking at price action using a telescope. This is where we are viewing from some way off, so we can see all the price action of the last few days.

Then using our telescope we start to zoom in, first onto the 15 minute chart, and then in fine detail to the 5 minute chart. By using the 15 minute chart we are seeing both sides of the price action - the centre lane of our highway or motorway. A slower time frame helps in gaining a perspective on where we are in the longer term journey, and a faster time frame on the other side will give us the fine detail view of the related price action.

What do we see here? First the shooting star sent a clear signal of weakness, and on our 15 minute chart this is reflected in two candles, with high volume on the up candle which is also topped with a deep wick to the upper body. And here the point is this. If we had seen this price action in isolation on the 15 minute chart, it may not have been immediately obvious what we were looking at here.

It takes a mental leap to lay one candle over another and imagine what the result may be. The 30 minute chart does this for us, and in addition, and perhaps more importantly, if we had a position in the market, the 30 minute chart is instantly more recognisable as possible weakness than the 15 minute. So two benefits in one.

If putting two candles together to create one is difficult, putting six candles together is almost impossible, and yet this is the same price action represented on the 5 minute chart. The market then moves into consolidation, which again is much easier to see on the slower time frame chart than the faster ones, and I have deliberately left the pivot points off these charts, so the charts remain as clear as possible.

The next point is this. In displaying a slower time frame above, this also gives us a perspective on the 'dominant' trend. If the dominant trend is bullish on the 30 minute chart, and we decide to take a position on our 15 minute chart which is bullish, then the risk on the trade is lower, since we are trading with the dominant trend. We are trading with the flow, and not against the flow. Swimming with the tide and not against it.

If we take a position against the dominant trend in our slower time frame, we are counter trend trading, and two conditions then apply. First, the risk on the trade is higher, since we are trading against the dominant trend of our lower time frame, and second, we are unlikely to be holding the position long, since the dominant trend is in the opposite direction.

In other words, what we are trading here is a pull back or a reversal. There is nothing wrong with this, as everything in trading is relative. After all a reversal on a daily chart might last several days. It is all relative to the time frame.

The third reason for using multiple charts is this also gives us a perspective on changes in trend as they ripple through the market, this time in the opposite direction. The analogy I use here is of the ripples in a pond. When you throw a pebble into the centre of a small pond, as the pebble hits the water, the ripples move out and away before they eventually reach the edge of the pond. This is what happens with market price action.

Any potential change in trend will be signalled on our fast time frame chart. This is where you will see sudden changes in price and volume appear first. If this is a true change, the effect will then appear on the primary chart, which in this case is the 15 minute chart, before the change ultimately ripples through to our 30 minute chart, at which point this change is now being signalled on the dominant chart.

This is how to trade, as we constantly scan from the slower to the faster and back again, checking and looking for clues and confirming signals between the three time frames, with VPA sitting at the centre of our analysis. Even if you ultimately decide VPA is not for you, trading using multiple time frames is a powerful approach which will give you a three dimensional view of the market. You can have more than three, but for me three is sufficient, and I hope will work for you as well.

Finally to end this chapter, I would like to include a short section on the candle patterns I have found work, and work consistently. And you will not be surprised to learn, all these patterns work particularly well with price support and resistance, as well as price congestion.

By watching for these candle patterns whenever the market is in a consolidation phase and preparing for a move, coupled with VPA and multiple time frame analysis, this will add a further dimension to your trading. And the patterns I would like to consider here are the falling triangle, the rising triangle, pennants and finally triple tops and bottoms.

Let’s start with the falling triangle as shown in Fig 11.13 above. As the name suggests, a falling triangle pattern is a sign of weakness. We can see immediately from the volume we are in a congestion phase, but in this case the market is also moving lower. Each attempt to rally is seen as a series of lower highs, and is a clear signal of weakness. If this market is going to break anywhere, there is a strong chance it will be to the downside, since each attempt to rally is becoming weaker and weaker in terms of the high of the candles. The floor of the congestion area is very well defined, and any sustained break below here will be signalled with volume.

As with all price patterns, the falling triangle appears in all time frames and on all charts, and we must always remember Wyckoff's rule of cause and effect. If the cause is large the effect will be equally large. In this case we are looking at a 5 minute chart, but this type of congestion will often appear on daily and weekly charts and is immensely powerful in generating new trends, or reversals in trend on the breakout.

Fig 11.14 is from the daily chart of the EUR/USD, and as we can see the rising triangle is a bullish pattern. In this example the market is moving higher and testing the same ceiling level, with the low of each candle slowly rising, signalling a market that is bullish. After all, if the market were bearish we would see the lows of each candle falling. Instead the lows are rising, suggesting positive sentiment in the market, and as we approach the ceiling (or resistance), we are prepared for the subsequent breakout, which is confirmed with volume. Once clear of resistance, the ceiling becomes support, and gives us a natural price barrier for positioning stop losses as we take a trade.

The third pattern in this series is the pennant, so called as it resembles a pennant flag on a mast.

Here in Fig 11.15 is an example of a candle pattern on a much longer time frame and is from the monthly chart for Microsoft and shows an extremely long congestion phase, but look at the contraction in the price action just prior to the final break out.

The pennant pattern is so called as it resembles a flag on a flagpole. The pattern is created by a series of lower highs above, as the market tries to rally, coupled with higher lows below. As we can see on the Microsoft chart, here we have a stock which is struggling to break higher, yet is not prepared to fall. It is this tension in the price action which creates this unique pattern. Again as with all these formations, the law of cause and effect applies, and in the case of the pennant the longer the tension continues, the more the price action creates what I call a 'coiled spring'.

In other words, the energy stored and built up in the price action is suddenly released in an explosive breakout. The problem is, that with this kind of pattern, unlike the previous two, there is generally no clue as to which way the price is likely to break. Nevertheless, it is a great pattern for trading direction-less strategies with options, but for trend trading, we simply have to be patient and wait for the break out.

The last two patterns in this set are reversal signals and ones I am always looking for. The market has risen or fallen, and is now testing support or resistance. As with the patterns already mentioned, these also occur in all time frames and on all charts and I want to start with some examples of markets which have run into resistance and are struggling to move higher.

Fig 11.16 is an example of a classic triple top pattern from the daily chart of the AUD/USD, where we can see the pair has tested the 1.0600 level on three separate occasions. This region has been tested several times over the last few years, but in the last year it has been tested three times, failing on each occasion. And here there are two opportunities.

First a position to the short side should our VPA and multiple time frame analysis confirm this view. Second, if the market breaks above this region, then this will build an extremely strong platform of support, if this ceiling is eventually breached.

The opposite of a triple top is a triple bottom.

In a triple bottom pattern, the market is testing support, and each time bouncing off. Our example of a triple bottom is taken from the hourly chart for the EUR/CHF (Euro Swiss) currency pair where we can see a classic formation of this pattern.

As with the triple top, there are two trading scenarios. The first is a long position, validated by VPA or wait for a break and hold below the support region, for a short trade. Any follow through to the short side would then provide strong resistance overhead.

The good news is we see all these patterns in every instrument and market. In bonds, commodities, equities and currencies, and in all time frames.

These patterns all have one thing in common - they are creating trading opportunities for us by signalling two things. First, an area where the market is in congestion, and second, a market that is either building a ceiling of price resistance or a floor of price support. From there will come the inevitable breakout, signalling a trend reversal, or a continuation of trend, and from there, all we need to do is to validate the move using VPA, and of course VAP, which will highlight these areas for us visually on our charts.

In the final chapter of the book I would like to expand on some of the latest developments in volume based trading techniques. After all, the approach and basic concepts have changed little in the last 100 years, so perhaps it’s time for some new developments.