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How to use volume indicator when trading cryptocurrencies

by | May 15, 2018

Volume Predicts Price!

In your quest to become the Wolf of Blockstreet, you have read or heard the previous statement one thousand times before. You may not have realized how important that statement is so I will write it another way, “Volume precedes price action.”

Even if you are a long-term hodler you should be aware of volume and its importance. If you are looking to buy and sell bitcoin you need to accept that statement as a fact. Price rises as demand surpasses the supply. As an investor, how can you measure demand? Volume. And thus, one last time. “Volume predicts price.”  

In today’s article, we are going to discuss a technical indicator called volume. And because “Volume” is not the most exciting indicator for trading we will also look to discuss “On Balance Volume” to give you a lead on the market.

Volume is the easiest indicator we can calculate. It is the amount of a security or commodity traded in a given period of time. Let us say in one hour of time, Mary bought 10 bitcoin, Joey sold 8 bitcoin, and Sally sold 2 bitcoin. Your volume is 20 bitcoin. So why is this simple indicator so important? When analyzing price action, you can use volume to confirm which way the price is trending.

Volume indicator in a standard setting is placed on the X-axis.

When price is increasing you would expect volume to increase as well. Because volume confirms a trend, during a bearish move you would expect to see volume increasing with lower lows as well. If price continues to move up on less volume you need to be cautious of the movement. When volume does not confirm the current trend, you could be headed toward a reversal.

Check out the photo below. This is an example of an uptrend without volume to confirm the trend. Remember: volume predicts price action. Remember reaching these all-time highs in December? Also, notice how volume continues to rise with the following downtrend. Confirming a new bearish trend. 

If the graph shows rising price, but decreasing volume, it means the market is not accepting the change and there are chances of a price reversal.

Now let us examine a bearish trend reversing. Price continues to fall. This time volume declined as well, not confirming the downward trend and warning of a possible change in trend. Remember that volume needs to increase to confirm the current trend. Price action moving up or down needs increasing volume to confirm a trend.

Similarly, in this graph the price for Bitcoin is decreasing but the volume is also going down, which shows that the price is most likely to regain.

Yes, this is evident in lower time frames as well. As you approach previous resistance you would anticipate a larger volume to break it. Look at our higher high with no volume to confirm the uptrend. It might be time to tighten up your stop and watch out for a reversal.

So you now understand volume, right? Volume is used to confirm a trend. You may be thinking, “Wow this is great, but by the time the volume confirms the trend, the trend has already happened and I missed the boat.” You’re one hundred percent correct, so let’s add another weapon to your arsenal called On Balance Volume.

On Balance Volume is a leading indicator. According to Investopedia, “OBV is a momentum indicator that uses volume flow to predict changes in stock price. Joseph Granville developed the OBV metric in the 1960s. He believed that when volume increases sharply without a significant change in the stock’s price, the price will eventually jump upward, and vice versa.” The thought is that smart money (institutions and whales with way more money than you) are buying and interested causing an increase in volume as price remains the same.

How is On Balance Volume calculated?

According to Investopedia, “The OBV is a running total of volume (positive and negative). There are three rules implemented when calculating the OBV. They are:

  1. If today’s closing price is higher than yesterday’s closing price, then: Current OBV = Previous OBV + today’s volume
  2. If today’s closing price is lower than yesterday’s closing price, then: Current OBV = Previous OBV – today’s volume
  3. If today’s closing price equals yesterday’s closing price, then: Current OBV = Previous OBV”  

This might seem a little confusing so let us use an example. In this example, we will calculate the On Balance Volume over a 5 hour period using hourly candles.

Hour 1: Bitcoin closing price is $100, Volume is 10,000 bitcoins traded.

Hour 2: Bitcoin closing price is $110, Volume is 10,500 bitcoins traded.

Hour 3: Bitcoin closing price is $115, Volume is 11,000 bitcoins traded.

Hour 4: Bitcoin closing price is $105, Volume is  10,500 bitcoins traded.

Hour 5: Bitcoin closing price is $105, Volume is 11,500 bitcoins traded.

 

Hour 1: OBV = 0

Hour 2: OBV = 0 +10,500 = 10,500 (read rule 1)

Hour 3: OBV = 10,500+11000 = 21,500 (read rule 1)

Hour 4: OBV = 21,500 – 10,500 = 11,000 (read rule 2)

Hour 5: OBV = 11,000 (read rule 3)

My cheat sheet rules for trading with the OBV:

1. Sideways price action

  1. Falling OBV predicts price would fall
  2. Rising OBV predicts price will rise

2. Price rising

  1. Rising OBV price will continue to move up
  2. Falling OBV (bearish divergence) price will go down

3. Price falling

  1. Rising OBV (bullish divergence) price will go up
  2. Falling OBV price will continue to move down

Time to make use of our OBV. Take a look: we have price moving sideways. However, we see our OBV slowly creeping up.  

The price follows the increase in OBV and increases as well.

One of my favorite times to use OBV is during bull flag and bear flags. Because this is a short-term trend, use a smaller time frame such as the 15-minute chart. At first, the chart below might look like a bull flag, but the OBV shows you otherwise. In this example, price is sideways but OBV is falling.


Price followed the decreasing OBV despite a bullish flag. The price went down.

Let’s take a look at this bull flag that actually went bullish. Notice below price is staying the same and OBV is rising. Then look how we broke out of the bull flag with more upward movement.

This works with larger time frames as well. Looking at bitcoin’s all-time high in December we can see the bearish divergence.

All in all, Volume and On Balance Volume are great tools to help you make decisions when trading Bitcoin. Remember, these patterns are not foolproof. There are times where these tools can end up making an incorrect price prediction. However, they can help manage your risk and give you an advantage over the average Joe. Hopefully, you learned something new. Have a great day!

Further Reading: How to use support, resistance, and trendlines

Disclaimer:

This article was written to the best of our knowledge with the information available to us. We do not guarantee that every bit of information is completely accurate or up-to-date. Please use this information as a complement to your own research. Nothing we write in any of our articles is intended as investment advice nor as an endorsement to buy/sell/hold anything. Cryptocurrency investments are inherently risky so you should never invest more than you can afford to lose.

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