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Ever since the financial markets were created, traders, investors, mathematicians, and anyone fascinated by their never ending ebb and flow, have tried to create the ultimate mathematically generated indicators to forecast their future direction. The sole purpose has been to give traders (and investors) the confidence to open a new position in the market. These indicators are then displayed in graphical format on the trading screen in a variety of ways.

Some of these mechanisms or indicators are more useful than others. However, what this constant search for the ultimate indicator that always forecasts the market correctly has produced, is a vast and ever growing library of what are referred to as 'technical indicators'. In most cases, these are simply 'price indicators' since this is really all a technical trader is interested in.

Over the decades, some indicators have developed strong followings, whilst others have fallen by the wayside. The problem for inexperienced traders is knowing which ones provide useful information, and which are perhaps less useful.

Moreover, for novice traders the temptation is always to have as many indicators as possible on the screen, in the hope they will align, confirm any trading signals and help to reduce the risk of the trade. This is perfectly natural and is a cycle almost all traders follow, before they finally come to the realisation the most important aspect of technical trading is price behaviour, supported by some simple, uncomplicated indicators which provide information that would be difficult to produce manually, and at speed.

In other words, price action or price behaviour is primary and, technical indicators are secondary. Technical indicators can certainly be useful and helpful in providing an alternative view of complex markets, particularly the forex market which is the most complex of all and I use several myself, but ultimately trading is a discretionary business, and one where trading indicators can only ever play a supportive role. Technical indicators should only every support a trader’s analysis, not replace it.

Unfortunately, many traders abrogate their trading decisions to a trading indicator through fear, which is entirely understandable when first starting out. In addition, it is also a lot easier to blame a bad or losing position on the market or indicator. Again this is perfectly normal and part of a trader’s learning curve. In fact one of the things you will need to decide is whether you are suited to a discretionary approach or a systematic one, and this will be dictated by your personality traits. There is no right or wrong way to trade, just what suits you and works best.

Perhaps one of the hardest lessons for any trader to learn is to take a loss, move on and not to take the loss to heart. This is easier said than done and, although I'm straying into the world of trading psychology here, this is one of the reasons trading indicators are so popular. They have much more to do with the psychology of trading, as opposed to whether they work. As I mentioned in a previous chapter, learning to trade is a lot like learning to swim. The indicators can be supportive while a trader is learning. However, the problem for many traders is they never learn to trade unaided, and continue to add more and more indicators, in the mistaken belief this will help to build confidence. Unfortunately, the opposite is more likely to be true. A trader’s screen ends up filled with coloured lines and flashing symbols which simply confuse, leading to indecision and further confusion.

However, there is no reason why traders should not use trading indicators, and in this section I want to explain the better ones and how to use them. Trading indicators can be found on all good charting and brokerage platforms, and for the purposes of this chapter I am going to focus primarily on those which are freely available, plus a couple I have developed for my own trading. My approach, as with everything I do, is to keep things simple.

The first thing to note about trading indicators is their only role is to provide supportive analysis to the price action on a chart.

Second, trading indicators fall into five principle groups, under two main headings. These are leading and lagging. As these terms imply, a leading indicator is one that truly leads the price whilst a lagging indicator is one based on historic price action. In the leading category there are only, whilst under lagging there are hundreds.

In the leading indicator category I would only include price as one, and volume as the other. I have to stress this is my own view and I'm sure there are traders who disagree.

Every other technical indicator is lagging the market. It has to be, since every one of these indicators has one thing in common. They use price history to construct the indicator, so are all lagging the true price action to a great or lesser extent. As I explained in an earlier chapter, some are better than others and, some work well under certain conditions, but perform less well when market conditions change. For example, one type of indicator may work when a market is trending strongly, but breaks down when the market moves sideways. This lack of consistency is one issue. The second is many traders simply do not know which indicator to apply in different market conditions.

The first group of indicators can loosely be termed as trend indicators. Many traders will know the well worn trading motto of ‘let the trend be your friend’, and trend indicators have been designed to help identify when a trend has formed or is forming.

Furthermore, trend indicators should also help traders stay in a trade once the trend as developed.

However, as I stated earlier, all technical indicators have their strengths and weaknesses and, whilst this group performs well when the markets are trending nicely, they perform less well when markets are moving sideways and price action is confined to a narrow range. This, of course, is only to be expected.

As a general rule, these indicators smooth out the price action into more consistent lines or patterns. By far the most popular are simple moving averages, which plot an average of prior prices over a user defined period. This then produces a simple line on the chart to project likely future price behaviour.

From this simple concept has sprung a plethora of other moving average based indicators including, weighted, exponential and multiple moving averages.

In essence, all traders are only interested in predicting a future price move. So, in theory, if an indicator can help us do this, it is worth using and perhaps the simplest of all indicators is the Simple Moving Average.

This is an indicator which looks back over a user defined number of periods. In Fig 18.10 the SMA is looking back over the previous five price bars and taking the average closing price of each of these. It then plots the line accordingly, based on this historic price action to suggest where prices are likely to move next.

In simple terms for each new bar the SMA will take the previous 5 prices on close, sum them together and divide by 5. This figure will then be plotted on the chart and is recalculated at the end of each session, or whatever the time period of the chart.

This is the simplest form of indicator. A simple moving average can be calculated for any time period. For example a 10 minute SMA, a weekly SMA, or any user defined period which is then plotted on the chart accordingly. The simple moving average is based on the price and calculated on every price change.

There are a number of ways traders use moving averages to find and place trades. One of the simplest is to enter a long position when a price moves above the moving average, and exit when it moves back below. The theory with this strategy is the indicator is providing a good guide to the overall trend.

Therefore, a trader will place a trade when the price is trending up, and exit the trade when the price begins to trend down.

Another very popular strategy using moving averages is to enter and exit trades when two simple moving averages cross one another. The theory here is that when one moving average crosses the other, it indicates a change in trend and is therefore a trading opportunity. In the example in Fig 18.11 the 15 SMA has crossed above the 50 SMA, suggesting a bullish trend is about to start and in this case, it did. This is on a weekly chart.

However, there is a problem with moving averages and it is this. The shorter the time frames used (such as 5, 10 or 15 periods) makes the SMA highly sensitive as it is very close to the price action of the market and therefore more likely to provide false signals.

Even the longer period moving averages, such as the iconic 100 or 200 moving averages, present their own problems. In this case, the averages are so far away from the price action traders may need significant capital to trade these moving averages.

There is also an entire philosophical debate about moving averages and in particular a debate surrounding the two averages mentioned above. I deliberately used the word 'iconic' to describe these, because they do exhibit some interesting characteristics, not least their almost ‘mystical’ quality in relation to price. The 200, in particular, is even quoted by the financial press whenever it approaches a key price point.

The question, however, as always is this. Is it the market reacting objectively to these price levels, or is it simply that with so many traders watching these indicators, they become a self fulfilling prophecy as a result?

After all, if all traders believe that a market is going to bounce higher off a 100 or 200 moving average, provided a sufficient number take positions on this expectation, the prophesy will be fulfilled. By the same token, if price breaks below one of these averages, many will enter short positions which will inevitably drive the price even lower.

Moving averages are incredibly easy to use and follow and in recent times have also been afforded a degree of validation by the financial media. This has further reinforced their authority and because they are seductive, they appear to work when applied to historic price action.

However, with so many traders looking at the same charts and having the same beliefs about this indicator there has to be an element of a self-fulfilling prophecy about them.

Over the years there have been many studies by leading academics, who have tested hundreds of different strategies using technical indicators, and in particular moving averages. All of these studies reached similar conclusions. The success rate of each strategy varied between 37% and 66%. The research suggests moving averages only give positive results about half the time, thereby making them a risky proposition for any effective market timing.

In other words they only work half the time, the problem is similar to the advertising conundrum. Which half and when. Generally of course, they will work well in trends, but then a trend is sometimes only obvious after the event, unless you understand volume and price, along with all the associated aspects of price behaviour such as congestion phases.

Nevertheless, they do have their place and I use them myself, albeit sparingly. I use them to give myself a perspective on price behaviour in different time frames. This is how they should be used. Giving traders a perspective, nothing more and nothing less.

Within this group there are many other indicators. Some have exotic and unusual names and these include: the Parabolic SAR, Rainbow 3D moving averages, and the KST indicator. They all have their fans in the trading world but, to be honest I have never used any of these so cannot comment on their validity or otherwise.

One indicator I have used for trading yen based currencies is the Ichimoku Cloud indicator for the same reason I watch the 100 and 200 period SMAs. Japanese currency traders use Ichimoku almost exclusively for trading, so it does have an element of a self fulfilling prophecy. I will be explaining Ichimoku in more detail later.

The second group of indicators I would like to examine is what I call strength type indicators, of which the most popular is of course volume. This is the fuel that drives the markets. This is the indicator I have been using consistently for more than 20 years. It was the indicator I started with as part of volume spread analysis in the futures market, in the days long before the internet.

Volume too is covered in detail later, within the concept of volume price analysis. Volume price analysis is my own methodology and the approach I use exclusively for my personal trading and investing, and in all my market analysis and forecasts. It is the approach I teach in my live webinars. I use it for all markets and instruments. I have recently written another book which explains this methodology in detailed, and is entitled: A Complete Guide To Volume Price Analysis. You can find further details on my site at http://www.annacoulling.com and since then I have added several other books with worked examples for all markets including stocks, cryptocurrencies and forex.

Volume (in my opinion) is the only indicator (other than price itself) that can be considered a leading indicator. Volume appears in real time at the live edge of the market, and the signals it delivers are then interpreted as part of the volume price relationship. It is because these signals are delivered in real time which makes volume and price so powerful.

However, in the spot forex market there is only tick volume, which is then used as a proxy for volume. Tick is activity and can be interpreted in exactly the same way using the same techniques.

It's not perfect, but when combined with all the other analytical techniques, price action analysis, and supporting technical indicators, provides a powerful way to interpret activity in the spot forex market. Furthermore, volume price analysis gives traders a huge advantage.

A second method of using volume is to consider related markets, such as the futures market or in equity markets. Price reversals can be seen in currency futures as well as in currency specific ETFs. The volume is there and at the live edge of the market, so can be harnessed and exploited. All other indicators based on historic price action are lagging whilst volume is leading because, like price, it is reported in real time.

The third group of technical indicators fall into the volatility grouping, and these indicators are designed to show fluctuations in price over a period of time. By far the most popular in this group are Bollinger bands, developed by John Bollinger. This is a series of lines creating a band which envelope the price on the chart. Bollinger bands utilise simple maths and standard deviation with the lines plotted as two standard deviations away from a simple moving average. Fig 18.12 is an example plotted on a monthly chart using a 20 period moving average.

As John Bollinger is the first to acknowledge, "tags of the bands are just that - tags, not signals. A tag of the upper Bollinger band is not in and of itself a sell signal. A tag of the lower Bollinger band is not in and of itself a buy signal". Price often can and does "walk the band". In those markets, traders who continuously try to "sell the top" or "buy the bottom" are faced with an excruciating series of stop outs, or worse, an ever-mounting floating loss as price moves further and further away from the original entry.”

A less than ringing endorsement from the originator.

I was introduced to this indicator many years ago when trading futures and reached the same conclusion. However, what the indicator was designed for and reveals simply and clearly is volatility. The squeeze describes when the bands narrow showing reducing volatility and then expanding as volatility increases.

There are several other indicators in this group, such as the volatility ratio, volatility, Chaikin volatility and many more. Again I have to confirm I have never used any of these, so cannot comment on their usefulness or otherwise.

The next group of indicators is what I call cyclical and, these are essentially indicators which look for patterns, or rather patterns of price action, that repeat or cycle. The two most popular in this group are Elliot wave and Fibonacci.

Fibonacci is based on the work of Leonardo of Pisa, who developed a number sequence based on the number series 1,2,3,5,8..... in which each number is added to the next in order to build the series. So, the next in the series here is 13. This number sequence also appears throughout the natural world, and has been developed into one of the most popular trading indicators, particularly for forex traders, with the Fibonacci retracement probably the most widely used application of the sequence. The most important retracement percentages are 23.6%, 38.2%, 61.8 % and 76.4% and, below is an example applied to a 5 minute chart. Traders also use the 50% level, even though this is not part of the Fibonacci sequence.

In the example in Fig 18.13 the market paused at the 61.8% where a large number of traders would have taken a short position based on this price action. However, the price simply consolidated at this level before pushing higher and eventually ran out of steam at the 100% level. This level too is not part of the Fibonacci sequence, but is related to Gann levels. However, traders have incorporated this percentage into Fibonacci. Fib levels are very popular but, once again I suspect there is also a strong element of a self fulfilling prophecy about them given the number of traders who use them. There is also some debate about where and to which levels to attach them to a chart. How far back? What is the high, and which is the low? All rather vague questions and to which there is no firm answer.

Another popular trading approach is Elliott Wave. Elliot Wave Theory was developed by Ralph Nelson Elliott, and is also premised on the principle markets move in waves or patterns, of higher highs and higher lows. This is certainly true, but for Elliott the key levels and patterns are all based around a cycle of three. Proponents of Elliot Wave will often add in some Fibonacci, and vice versa. A little Gann may also be included, just for good measure, so once again 50% and 100%, which are key Gann numbers become important. Once again, although I strongly believe there is an element of a self fulfilling prophecy surrounding these numbers, as traders we should at least be aware of them, even if we never use them (like me).

Finally, there is a large group of indicators which loosely come under the term momentum. These indicators generally sit at the bottom of a price chart and have been designed to determine and plot the strength and weakness of a trend. This group of indicators is also mapping the speed at which prices are moving over a given period of time with any divergence between the price and trend signalling strong or weak momentum, and therefore a potential change in market direction.

The two most popular are MACD (Moving Average Convergence Divergence) indicator and the RSI (Relative Strength) indicator. The MACD is a convergence and divergence indicator which uses moving averages. By contrast, the RSI indicator averages out the price history to try to forecast whether a market is over bought or over sold.

Many traders are taught to use MACD convergence and divergence to take trading positions. The theory is that where the price movement is at odds with the trend of the MACD indicator, the price is likely to turn.

Fig 18.14 shows a chart with the MACD indicator applied on a 5 minute chart.

The MACD is another hugely popular indicator, which while working well in trending markets, can give a huge number of false signals when markets are moving sideways. The problem is always trying to forecast when a market is going to break into a trend. However, my philosophy here is very simple. If you can understand price patterns, and when a trend is about to start, or is possibly coming to an end, why do you need the MACD. After all, as I explain later, and in my book on volume and price, it really is very simple, if you can just take a little time to learn and understand how to identify where trends are borne, simply from studying the price action and associated volume. It really is self evident once you begin to study volume price analysis or VPA.

Finally, the RSI indicator which represents a key concept for forex trading, as currencies are constantly moving from oversold to overbought in every time frame. It is the nature of this market as a currency will never move to zero, so identifying these turning points is an important skill forex traders need to acquire.

In this respect the currency markets are unique. For example, when trading gold or gold futures there is only one instrument which is being bought or sold. However, when trading forex a currency can be bought and sold against any number of counter party currencies. For example, in the case of the US dollar, this can be bought against a host of other currencies, not just against the majors. So, when the US dollar is being bought, this may be against all other currencies, or just a few. This is one of the issues that makes forex trading unique and complex. Moreover, a bank or large institution wanting to sell euros and buy US dollars may not take the most obvious route through the EUR/USD pair. Instead, selling of a large volume of euros could be against the British pound, with the result they are now sitting on a quantity of British pounds. These could then be sold against the US dollar and the result would be the same. This is why understanding and identifying when a currency is strong or weak is the first step in any analysis. The next step is to identify where that strength or weakness is appearing and trade it accordingly.

This can be seen quite clearly on the charts where the US dollar may be rising against one currency, but falling against another. This is probably my most important forex trading tactic and is where I have developed my own personal proprietary indicator. This indicator identifies for me those currencies which are strong and those which are weak. Which are rising together or falling together and therefore not in a trend. And most importantly which are overbought and which are oversold and therefore likely to reverse. From there it is a simple task to check all the charts for that currency and identify possible trading opportunities. It is my own personal radar system on the forex market. Individual currency strength and weakness is displayed graphically and is so quick and easy to identify, thereby replacing hours of cross checking and comparing charts. This is where an indicator fits in. It delivers complex information quickly and easily and in an intuitive format, guiding you to those trading opportunities for further analysis.

In many ways this is the key to trading indicators. It is when they offer something of value, which can then help with any analysis and short cut the process. Unfortunately, most of the indicators I have examined in this chapter are promoted as providing entry and exit signals, which they do not. In addition indicators only work under certain market conditions. Some work in trending markets, whilst others only work in sideways or congested markets, and the problem for traders is often knowing what the market is doing at any one time. This is where it comes down to understanding price behaviour and having the skills to analyse what is happening on the chart which no automated system can do. The reason is that the interpretation of price action is, not only highly subjective, but also highly nuanced.

A further problem with technical indicators is often traders who use them have little or no idea of the algorithms driving them. Therefore, when traders apply them to their charts, the chances are many of these indicators will be executing similar calculations, but in slightly different ways. This can result in indicators giving conflicting signals, and rather than boosting confidence, adds further confusion and can lead to a loss of confidence.

My advice is, therefore very simple and amounts to a three step process. Step one, and the starting point for any trader, is understanding price action by way of candles and candle patterns. Step two, is to develop the analytical skills related to price behaviour. These skills include how to recognise the six phases of price behaviour. Finally, step three is to add in only those trading indicators which will act as support mechanisms. The trading indicators should be there to help and not to hinder or confuse. This is the approach that will ultimately lead to trading success.

Before moving on to consider volume in detail, I promised to explain one type of indicator which I've used when trading in the Japanese yen pairs, namely Ichimoku Cloud. The reason being the majority of Japanese currency traders also use this technical indicator. If you have ever seen the trading floor in a Japanese bank you’ll know what I mean. It is extremely popular with forex traders and, in many ways, this indicator is testament to the concept of a ‘self fulfilling prophecy’, particularly for the yen pairs.

The first and most important point to make about Ichimoku is that this indicator should only be used with longer term time frame charts. It is particularly suited to daily charts and above and is not really suited to intraday trading.

At first glance, Ichimoku can appear very confusing, so let me try to explain the elements which make up the indicator before moving to a chart.

The indicator uses simple candles and candle patterns along with two moving averages, namely the 9 and 26 SMA. However, these moving averages are calculated using the mid point price which is why they appear as a spiky line on the chart.

These two moving averages can have a variety of names depending on the charting package or programme. The nine period SMA can be known as any of the following: Conversion Line, Turning Period or, by its Japanese name of Tenkan Sen. Meanwhile, the twenty six SMA can be referred to as Base Line, Standard Period or, by its Japanese name of Kijun Sen.

Finally, there is one more number that needs to be added to the charting package, before it will draw the chart and this is the number fifty two. This third time element is again called various things by different packages, but these are the ones I have come across. Leading Span B, Span B, or Period three. Its correct Japanese name is Senkou Span B.

Whichever name it has, this needs to be set at fifty two. Although, this line is similar to the two simple moving averages in that it is calculated by taking the average of the highest high and the lowest low for the last fifty two periods, it then takes this information and shifts the line forwards by twenty six periods, giving this indicator the unique ability to project forward into the future.

Therefore, the Senkou Span B line is 52 as it is based on a two month period of the twenty six day working month, but time shifted ahead to give a one month future view of the market.

So, to recap. When setting up Ichimoku on any charting package traders have to input three numbers, nine, twenty six and fifty two which create the three lines on the chart. The Tenkan Sen is the modified 9 period SMA, the Kijun Sen is the modified 26 period SMA, and the Senkou Span B is the one month simple moving average look ahead line shifted twenty six periods forward.

Finally, the chart has two other lines. The first is the Senkou Span A, also known as the Leading Span A. This line is the average of the 9 period SMA (the Tenkan Sen) and the 26 period SMA, (the Kijun Sen). In other words, an average of these two SMAs. The Senkou Span A is then plotted twenty six periods ahead and forms the envelope which appears as the cloud.

So, the cloud is formed between the two leading lines which are projected into the future, the Senkou Span A and the Senkou Span B and it is this construction which gives this indicator its unique appearance.

Last there is a fifth and final line which is a lagging line called the Chikou Span, which is the closing price of the period plotted twenty six periods behind.

Once the indicator appears on the chart it can be used in three ways. First, by taking the crossover signals of the 9 and 26 SMAs. So, if the 9 moves below the 26 SMA this gives a bearish signal, and moving above the 26 SMA gives a bullish signal.

Second, is the cloud itself which is the key feature of this indicator, and it is important to realise the clouds themselves reveal several things. First, the thickness of the cloud is important, and just like real clouds, the thicker they are the heavier the atmosphere or pressure. So, a deep thick cloud indicates the market is likely to struggle to break through this area. This is similar to support and resistance, which I am going to cover shortly.

Therefore, if the cloud is above the market this is a bearish signal and if the cloud is below the market, as it is shown in Fig 18.15, then this is a bullish signal.

If the cloud is thin the market could reverse and change direction, whilst a thick cloud suggests a strong trend and a barrier to any reversal in the trend.

With the forecasting element (the look ahead if you like) of the indicator, what traders are looking for is a cloud that is becoming steadily fatter and fatter, reducing the chances of a trend reversal and giving confidence the trend is likely to continue. If the cloud is very thin, or becoming thinner, as it seems to be in Fig 18.15, this suggests a possible reversal is in progress and traders need to be cautious in trading the longer term trend.

With regard to the Chikou Span (the lagging indicator) this is used in the following way. If the line is above today’s candle then the market is considered to be bullish, but if it is below today’s candle then the market is considered to be bearish in the longer term. On the chart in Fig 18.15 this line is below the last daily candle, so traders can expect a change in trend in due course.

Equally, if the Chikou Span is above the current cloud then the market is viewed as bullish, and if below the cloud it is bearish, so many things to consider with this interesting and little used indicator.

As all forex traders know the forex market is unregulated and with no central exchange there is no reported volume. In other words, there is no equivalent to the volume reported in virtually all the other markets, either directly as in the cash markets such as equities or, indirectly in the futures market. However, this is not necessarily a drawback, not least because there are some exciting new developments in the use of tick volume. There are software applications that are increasingly able to mirror what is actually happening in the interbank forex market, by interpreting the tick volume and creating a volume chart to represent both the buying and selling. These applications are becoming increasingly common and as I mentioned in an earlier chapter, tick data is activity or flow and therefore volume. Furthermore, studies have shown using tick data as a proxy for volume can be extremely effective and a reflection of the buying and selling activity in the market.

Volume is therefore becoming ever more important in forex trading, and here I would like to outline in more detail the technique I use, namely volume price analysis. This is the analysis of volume and the associated price action on the chart which is most likely to reveal the future direction of the market. This is a big subject, and one which I cover in great detail in a separate book. However, I would like to cover the basics and explain why it is such an important concept. Not all traders are convinced of the power of volume and price but, I hope to provide sufficient and compelling evidence of its effectiveness.

There are many reasons why, in my humble opinion, I feel so passionately about volume and why it can be considered a true leading indicator, not least because it appears in real time and at the live edge of the market. Furthermore, volume is not a mathematical indicator based on historical price data which is then displayed after the market has moved on. Volume is real and reported every second throughout the day. It is also displayed live in the same way as price appears on the chart.

Moreover, when considering volume and analysing the price action associated with it, the net result is a unique indicator which tracks the market in real time and, perhaps more importantly, any analysis is trader based and not reliant on any external factor.

It has been said many times volume is the fuel that drives the market. Volume reveals activity and whether the buyers or sellers are out in force. Conversely, it also reveals whether there are few or even no buyers or sellers.

A way to imagine volume is to think what happens when the retail stores begin their sales. First, the sale signs go up, promising big discounts on prices. People start to queue to snap up the bargains and as the day approaches the crowds grow, until the doors of the store opens and the crowds rush in. This is volume at work.

There is a similar pattern of behaviour in the financial markets. The market moves lower and the buyers come out and start buying in volume, snapping up the bargains and eventually cleaning out the store.

However, it is linking this activity to the price which reveals what these buyers and sellers are thinking and more importantly what they are doing. A correct analysis of what is happening will not only validate the price action, but also forecast future price behaviour. This is why volume price analysis is so powerful.

After all, to return to the store example, if the sale attracts very few buyers this would be signalled by low volume and prices would have to fall, perhaps quickly, in order to attract the buyers into the store. On a price chart this would be illustrated as a narrow spread down candle (a hammer perhaps), with a high volume bar below, giving a clear signal the buyers are in the market and buying at this price point.

Therefore, in studying volume and its relationship to the associated price action, traders are only looking for two things.

First, confirmation that volume and price are in step with one another. In other words, does the price action reflect the volume and vice versa. If the answer is yes, the move higher or lower is genuine and the volume is confirming the price action on the chart. Volume validates price.

Second, anomalies where the price action does not reflect the associated volume or vice versa, which could be an early warning signal of a potential change in direction for the market

This, in very simple terms, is what to look for in terms of price and volume. In other words, is the volume validating and confirming the price move. If not, then it is question of ‘trader beware’.

There are also one or two other factors surrounding volume which are often misunderstood by traders. One is the concept of high volume in terms of both rising and falling prices. The concept of something needing effort to rise is familiar and easy to grasp. Acceleration which increases the power of an engine to drive up hill is also easily understood. The same principle applies if price is to move higher. Volume is required and without it, price simply stalls.

Of equal importance, however, in the context of price is that power is also needed to move prices lower. Fuel is also needed because prices do not move lower simply on gravity. Without fuel, any move to the downside would also stall.

At this stage let me just write a few words about market manipulation. Market manipulation is a fact of trading life. It happens in virtually all markets, with the possible exception of the futures market which is considered a zero sum game. In other words, the exchange regulates and manages this market, and simply matches buyers with sellers. However, even here we have the appearance of the large operators who are able to move the markets, which is once again revealed in volume. Therefore, if a trader buys a futures contract another trader has sold a futures contract. When that contract is closed or expires the profit on one side of the contract will be matched by the loss on the other side of the contract. One trader’s loss is another trader’s gain.

Meanwhile, manipulation in the equity markets is by the market makers, who are responsible for making the market, and who also have a legal obligation to have stock when buyers want to buy, and accept stock when sellers want to sell. Market makers can best be described as 'wholesalers in stock' repeatedly buying and selling the same stock time and time again. And in order to ensure they have sufficient stock in their warehouse at any time, they use the news to move the markets up and down to either frighten investors into selling, or to encourage investors to buy. This is done using the twin levers of fear and greed.

However, the only activity market makers cannot hide is volume which reveals everything a trader needs to know and whether a market move is genuine or false.

Market manipulation also occurs in the forex market and it is the most manipulated of all for a number a reasons. First, there is no regulation and very little control. Second, the interbank market which sets the exchange rates, is dominated by a handful of major banks who between them control around eighty per cent of all the trading volume on a daily basis. Third, the central banks also play their part via overt and covert interventions. Moreover, it is further compounded by some brokers who trade against their own clients.

And the basic principle of understanding volume price analysis is this. We want to follow the insiders, the market makers. After all, they know where they are moving the market to next, so doesn't it make sense to follow them? So when we are considering volume, we view it from the perspective of the market makers as they cannot hide volume. We buy when they buy, we sell when the sell, and stay out when they are not participating. It is these simple principles which govern everything else.

Finally, just to round off this introduction to what I believe is the single most important indicator, let me include some additional concepts, and then I'll outline how to use volume and price to analyse the market.

Volume is also valid for longer term analysis using end of day data. A swing or longer term trader (or investor) can use an end of day chart with the volume reported to analyse risk appetite and money flow across all markets. This would help to reinforce, validate and confirm the trend in the instrument under consideration. In this case, volume on a longer term chart can give accurate signals as to the longer term trend. For forex traders looking to take longer term positions these trends can be found in markets and instruments such as ETFs and futures.

Intra day forex traders have the choice of using live tick data or the volume which appears in the currency ETFs or futures market. Whichever is used the principles of volume price analysis are identical.

I sincerely hope I have started to make a convincing case for the importance of volume. It really is a unique indicator which, when used correctly, is one of the very few indicators that can give traders a view of the market in real time.

Having looked at volume and its importance as an indicator across all the markets, I would now like to explain volume price analysis and how this technique can be used to identify and confirm signals as they arrive on the charts.

The first step is to set up the volume indicator. This is very easy. Simply select ‘volume’ from the add indicator tool menu and this will then appear in a separate section at the bottom of the chart. Beneath each candle will appear a vertical bar which is the volume for that particular time period. Fig 18.16 is an example from the MT4 platform.

The first thing the volume indicator confirms is the activity for the period in question. In equities it would be the number of shares traded, but in this case it is tick volume which is displayed.

Second, when compared to previous bars it is easy to see whether this volume was high, medium or low. This clear visual picture is one of the beauties of volume. The relationship between the volume bars is there to see, can be judged accordingly.

Traders can spot whether any volume bars are high, medium or low instantly. Of course, what these volume bars do not reveal is whether the volume displayed is buying volume, or selling volume. And the answer to this lies in the associated price action, the candles and candle patterns.

This is generally signalled by any anomalies between the volume and price and as such, the anomalies will signal potential trading opportunities and reversals in trend. They will also reveal whether the market makers are buying or selling, or perhaps just sitting on the sidelines and not participating.

The best way to explain this is with some simple examples and all of these are using the spot forex market on the MT4 platform. However, the same principles would apply on a futures chart for commodities or currencies, a cash chart for equities, or on an index chart. All have volume and this will help you when considering price action in related markets, using relational analysis.

The example in Fig 18.17 is a 1 minute candlestick chart with the volume indicator, and the area of the chart I would like to focus on is shown by the rectangular box.

Here the market has been moving sideways for a few bars prior to arriving at the region denoted by the box, with both the volume and price meandering along together and doing nothing of particular interest. The first volume bar appears in the box, and the price action is again narrow, but nothing unusual. However, on the next candle, the price breaks out from this narrow range and starts to move higher and, coupled with this move higher in price, the volume is increasing also.

This is what traders should expect to see. There is a nice up candle, with no wicks either to the top or bottom, and rising volume accompanying the move higher. The moves in both price and volume are congruent as it takes effort for price to move higher (and lower). Effort is being used to take the price higher and all is well as the price continues to move up, fully supported by rising volume.

As the subsequent bars form, once again the price is rising with rising volume. This time, the volume is higher than the previous bar and the spread of the candle is also wider, which again is what is expected. After all, the wider the spread of the candle, the more volume will be required to push the price higher. So both the price action and the associated volume are in agreement. It also validates the previous candle and volume bar. So far all is well, with widening candles, supported by rising volume.

By the time the fourth volume bar is displayed, the first thing to note is once again it is higher than the previous three volume bars. Volume is clearly rising, but the associated price candle is not as expected. This candle has closed with a narrower spread than the previous three. The price spread on this candle is clearly not in line with the spread of the previous candles and, clearly not in agreement with the volume. If price and volume are directly related and price requires effort to rise, by closing with a narrow spread on rising volume can only signal one thing. This candle is signalling weakness because, if the market were strong this candle should have closed as a wide spread up candle, wider than the previous candle. In fact, it has closed with a narrow spread with wicks to both the top and bottom. Not a sign of strength but, a sign of weakness. This is what the price volume relationship is signalling here.

Therefore, in this instance the volume associated with the price action can only be selling because, had it been buying volume, the price would have risen higher on strong buying. It did not. The price stalled, so clearly much of the associated volume must have been selling volume. In other words, sellers have come into the market at this level and caused the market to stall. If this had been pure buying the candle would have been wide. The price has tried to rise, as shown by the wick on the top of the candle, but the sellers have knocked the price back down. The sellers have not necessarily won the battle, but they have certainly stopped the EUR/JPY in its tracks at this level. All this has been signalled by an analysis of the volume and price. Clearly the market makers are selling into short term weakness here.

This is a clear anomaly and once alerted, traders can now watch for a trading opportunity. The high volume should have seen the price continue higher – it did not, so traders can safely conclude much of this volume is selling volume, as the buyers are losing momentum, and the market makers are selling.

The next stage is the subsequent bar that forms as a narrow spread down candle with average to high volume. This is telling us the price attempted to rise but failed and closed lower. Furthermore, in doing so the resulting candle is an ‘inside day’ signalling indecision and a possible reversal. It is also important to remember an ‘inside day’ candle can also be a pause in a trend which may resume once the price breaks above the high of the candle. Alternatively, it could be signalling weakness, and a reversal of the trend.

In this example the subsequent candles fail to break above the high volume up candle at the top of the trend, and candlestick analysis confirms this bullish trend has come to an end with a bearish move likely to start. The question, of course, is whether this move lower is strong or weak, and once again it is volume which provides the answer.

As each subsequent bar forms two things become clear as the trend develops. First, the bars are accompanied by a series of volume bars which are falling and not rising. Remember, for price to move lower, it too requires effort so, if price is falling strongly, expect to see rising volume and not falling volume as shown here. Rising prices require rising volume and falling prices also require rising volume.

Second, over the next 10 to 12 bars, the price spreads on the candles are all quite narrow and price is bearish. So, in this time frame it would present an opportunity to scalp. However, what the price/volume relationships is also telling us is this move lower is lacking momentum, clearly signalled by the falling volume and the narrow price spreads. This chart is sending a very clear message.

First, the ‘inside day’ candle gave the signal of a possible reversal, and once confirmed presented a scalping opportunity. Second, with falling volumes and narrow price spreads, it is clear the price is not going far, so any short positions are not likely to last very long. The move lower is a pause point and likely to be characterised by low volumes and price consolidation.

This is the conversation I have with myself as I watch each candle form along with the associated volume. What I am attempting to do on every candle, is to interpret what I see in the price, and match this to the associated volume. If there is an anomaly between the two, what is this telling me? Is the volume likely to be buying or selling and is this a possible turning point in the market or merely a pullback?

As can be seen on the left of the chart this currency pair has been moving sideways over three bars, on low volume. The price is going nowhere.

Then a wide spread down candle accompanied by rising volume appears on the chart. This is as expected so perhaps the currency pair is preparing to move into a bearish phase, but there is no anomaly here, because a wide spread down candle and rising volume is perfectly normal.

However, the subsequent candle is interesting, and is a shooting star candle in shape, but has appeared at the bottom of the trend. When this happens the candle is often referred to as a gravestone doji. Volume is rising, and the price action is the first signal buyers are coming into the market.

It is the buyers who have tried to stop the market moving lower, but on this occasion have been overcome by more sellers, and the price has been pushed back down to the open. However, the key point here is this is the first sign buyers have entered the market.

This is followed by the first of four hammer candles, all on high volume, a clear signal of buying by the market makers. After all, if this were selling the price would have fallen further. It hasn't. The hammer candles and the associated volume are sending another clear signal this is buying, and strong buying too by the market makers. The sellers have tried to move the market lower but the market makers have stepped in to prevent it falling further, and are simply absorbing the remaining sellers.

The price tries to rise, but the volume is falling on these next two candles, with the second having a very narrow spread. So, whilst there has been confirmation the price is preparing to rally, traders need to wait and be patient. Indeed, there is a further minor sell off in the next candle, but only on average volume. It is clear this is not a strong move lower. It could even be a move to take out stops.

This is immediately followed by the second hammer candle which is accompanied by even higher volume than on the first, sending a very clear signal. Once again the sellers have tried to take the price lower but, the market makers step in once more.

At this point, the price tries to rally on the next bar, but the spread of the candle is narrow, and the volume is above average. In this instance, whilst it is clear the buyers are taking control, there is still selling resistance to be 'mopped up' and this is a perfect example of the point I was making earlier about the power of the hammer candle. It is a strong and powerful candle, but traders need to patient and wait for validation. Markets do not turn on a dime. Selling pressure has to be absorbed by the market makers completely, before the price can move higher and, here is a classic example with four hammer candles of which this is the second.

The market then moves on for the next four candles, up and down in classic consolidation as the buyers and sellers struggle for control. After four of these candles the third hammer candle appears and, once again is accompanied with above average volume. However, the volume is not as high as on the second hammer, but is still buying volume - it cannot be anything else. Once again, the price has moved lower only to be pushed back higher to close near the open to form the classic hammer, and again the market makers are absorbing the selling pressure.

Price rallies once more and the fourth and last hammer candle makes its appearance, which finally confirms the market is preparing to move higher, as the candle is accompanied with above average volume.

Finally, the currency pair manages to break above this sideways price congestion (another key signal which I will explain shortly) and the trend starts to develop, with rising volume and rising prices until the move starts to peter out at the top of the rally, for two reasons.

The first sign of weakness in this rally is the narrow price spreads with high volume. After all, high volume should be associated with wide spread price action in the candle, and here this is not the case as the price approaches the top of the trend. Second, at the top of the trend there is a shooting star candle with above average volume which is validated with a bearish candle on the following bar along with rising volume. This trend appears to be coming to an end.

At this point in any long position, traders should be looking to tighten any stop loss to lock in some profits, or even close out a portion of the position.

Finally, to round off this section on volume and its role as the only leading indicator with price, I would like to finish with another simple, yet classic example in Fig 18.19 as confirmation of the power of this trading approach.

Once again it is an intraday chart, the 15 minute chart. This pair had initially been drifting lower, before picking up some bullish momentum as evidenced by nice wide up candles, supported by rising volume. However, what is clear on the two consecutive wide spread up candles, the volume on the second is lower than on the previous one, signalling perhaps the move is starting to run out of steam.

This is a purely subjective view and not a signal in itself – it is merely a possible early warning before the appearance of a premier candle, which in this case is a classic shooting star. On its own and in its own right, the shooting star always signals weakness and a potential reversal. The reason is straightforward.

The price has risen, pushed up by the buyers, but the sellers have come into the market and knocked the price back lower, to close near the open. What gives the candle such authority now is the significant volume associated with the price action and here is a classic example of a powerful reversal candle, with huge volume below. The volume here must be selling volume, and there is a lot of it.

What is clear is there has been a huge amount of effort to push the price higher but, all this effort has failed and the move is now looking very weak. The market makers are selling into weakness. Clearly, if all this volume had been buyers, the candle would have been wide and up, and not a reversal candle. In other words, the price would have continued higher, but it hasn’t. The market is now resistant to higher prices and regardless of the effort put in by the buyers, they are immediately overwhelmed by the sellers.

This is the descriptive picture being presented by the combination of price and volume. The message is clear. Expect the market to move lower, and soon. The market makers are selling and selling strongly.

With this signal, traders are now ready and waiting. By checking other indicators, and using the analytical techniques I am going to cover in the next chapter, these will validate this price action. Trading success is all about quantifying risk. It’s why I use a three dimensional approach in my trading.

Boil it all down to the essence of what we are trying to achieve, and its simply that - to quantify the risk. On the balance of the information I have from my relational analysis, weighted with the fundamental picture, and validated with volume price analysis, is the risk high, medium or low? That in a nutshell is all we are trying to achieve. Overlay this with multiple time frames and hey presto - risk is quantified.

It is the price volume relationship that gives traders the visual signals to prepare for a reversal. Price and volume leading the way once again.

As I mentioned earlier I have recently published a separate book which covers this subject in much more detail. Here I have just introduced you to the basics of volume price analysis, but if you are interested in discovering more, the book details are on my personal site www.annacoulling.com and you can find this one and many others on Amazon in both Kindle and paperback format.