Volume is highly relevant to binary options traders. It can help you identify profitable trading opportunities and avoid bad ones. This article explains how binary options traders can use trading volume for their trading.
In detail, this article will answer these questions:
- What Is Volume?
- Why Is Volume Important?
- How Can I Measure Volume?
- Trading Volume With Binary Options
With this information, you will immediately be able to add these values to your strategy and trade binary options with added confidence.
What Is Volume?
The volume defines how many units of an asset changed hands during a period. For example, when you are looking at a price chart with a period of 10 minutes and the last period had a volume of 1,000, 1,000 stocks swapped hands during this 10-minute period.
There are two important things to point out here:
- The value measures the number of assets, not traders. A value of 1,000 indicates that 1,000 assets were traded during this period, not that 1,000 trades were made. The 1,000 assets could be only one large trade or they could have been 1,000 separate small trades – the volume would be the same in both cases.
- Volume measures the underlying asset, not the number of binary options. A value of 1,000 indicates that 1,000 units of the underlying asset (the stock, index, currency, or commodity) were traded, it does not indicate the number of binary options traded based on the asset – the volume does not measure binary options.
Some traders would argue that it is unimportant whether the overall volume is the result of one large trade or many small trades. What matters is the overall relationship between demand and supply, and nothing else.
Also, it is important to understand that it only measures traders who buy or sell an asset. Binary options traders only make predictions about what will happen to the price of an asset, they neither buy nor sell it. Therefore, the volume ignores binary options. Some newcomers try to use this value to understand which assets are popular with binary options traders. That is not what the indicator does. Unless your broker specifically provides an extra indicator for binary options, the figure always indicators classic buy/sell supply and demand.
Why Is Volume Important?
To understand why this is important, consider these two scenarios:
- During a time with historically low volume, only two traders are left in the market. One of them decides to test his luck and places a buy order far below the current market price. The asset trades at £100, the trader sets a buy limit at £90. The other trader makes the rookie mistake of placing an unlimited sell order. Since the £90 offer is the only offer, it is also the best one. The asset jumps down by 10 percent and switches hands.
- While the U.S. stock exchanges were closed, the government published new economic data. The country is doing great, years of prosperity lie ahead. Many traders react enthusiastically and place buy orders. As the market opens the next day, all of these orders create a strong surplus of demand, and the market significantly jumps upwards by 3 percent.
In both situations, the market has shown a strong movement. In the first example, it jumped by 10 percent, in the second example only by 3 percent. Nonetheless, the second example would offer the better trading opportunity. The volume helps you understand why:
- In the first example, the price jump was the result of a single trader’s mistake. There is almost no chance that the majority of traders will consider this jump justified. It will conflict with the concepts of both technical and fundamental analysis. Consequently, the overwhelming majority of traders will invest against the movement. They will think that now is the right time to take advantage of a market that has moved too far, which is why the market is likely to reverse and eliminate the original price jump.
- In the second example, the price jump was the result of many traders doing the same thing. There is significant support for this movement among traders, and it seems more than likely that other traders will soon make the same investment decision, or that traders who already have invested will invest again. The overwhelming majority will invest in support of the movement, seeing it as the beginning of something big. The movement is likely to last for a long time.
Of course, most real-life trading situations will be less black and white than this example. But the volume can nonetheless help you understand the importance of each single period. When a period has a high volume, its movements are usually more important to future price action than the movements of periods with a lower volume.
Simply put, remember this relationship:
- Low period are weak because they lack the support of many traders.
- High volume periods are strong because many traders support their price movements.
Even during trends, periods in the main market direction often show a higher volume than periods against main trend direction. By monitoring this, you can understand what is happening.
How Can I Measure Volume?
There are many ways in which you can measure volume. The two most important of them are:
- Directly, and
- Through technical indicators.
Let’s take a closer look at each of them.
How To Measure Volume Directly
The simplest way of measuring volume is direct. Most chart software offers a tool that can draw the volume directly into your chart. Sometimes, the tool is active by default, sometimes you have to add it manually but is almost always there.
In the chart below, the volume is symbolised by the thin upwards bars at the bottom of the chart. The length of the bars indicates the volume of the period.
- Longer bars represent a higher volume,
- Shorter bars represent a lower volume.
As you can immediately see, the figures vary heavily. To understand how the volume can help you trade, take a look at the last two candlesticks. After a sideways movement with relatively low volume, the market started to fall in the second-to-last period but eventually closed in the plus.
Experienced candlestick analysts will immediately recognise this candlestick as a hammer. The hammer indicates upwards momentum because the market apparently turned from a strong downwards movement to a strong upwards movement during the period. This movement is likely to carry over to the next period.
Candle Patterns
The problem with the hammer is that it is unreliable when traded alone. During the previous sideways movement, the market formed quite a few hammers but always failed to act to continue to rise. The last hammer was different, but how are traders supposed to distinguish false signals from good ones? That’s where the volume comes in.
When you look at the previous hammers, you will see that they all featured a low trading volume. This is why their implications were weak – not many traders backed the movements, they might be the result of just a few errant trades.
The hammer in the second-to-last candlestick featured a much higher trading volume. Its bar is more than twice as long as the previous bars, which implies that something motivated traders to buy during this period.
Volume Analysis
Backed by many traders, the implications of the last hammer are much more significant than those made by the earlier ones. Once you see this hammer, it would be a great time to invest. The following large upwards candlestick is the likely outcome of the high volume.
This is why this analysis can help you to filter signals and understand the importance of single candlesticks. A sudden rise in volume very often indicates that a candlestick is of high importance and that the market will continue to move in the direction it implies. Often, it starts a strong movement.
How To Measure Vol Through Technical Indicators
Some technical indicators create volume based predictions about what will happen to the price of an asset. There are too many technical indicators that consider the volume to present them all at this point, so we will focus on the most popular of these indicators: the Money Flow Index (MFI).
The MFI compares rising to falling periods. It multiplies the length of each period with its volume and multiplies it with the volume. It then puts the sum of all rising periods in relation to the sum of all periods with falling prices. The MFI displays its result as a value between 0 and 100 that indicates the percentage share of volume-weighed rising prices.
- A value of 100 would mean that all the money flowed into the asset.
- A reading of 0 would mean that all the money flowed out of the asset.
- A score of 50 would mean that the amount of money flowing out of the asset was exactly as high as the amount of money flowing into it.
Volume Weighting
The volume is the weighting factor that determines the importance of each single period of the MFI. Periods with a higher volume are more important to the MFI’s result than periods with a lower volume.
This is why the MFI can open your eyes to completely new insights about what is going on in the market. While you can analyze the price action and the volume on their own, it is difficult to combine them. There is simply too much data to make sense of it.
The MFI probably is the most popular volume-based technical indicator. There are many other technical indicators that use the volume, too. For example, you could consider trading one of these indicators:
- Accumulation/Distribution,
- On Balance Volume,
- VIX
These and many other volume-based indicators can provide a solid basis for a binary options trading strategy.
Trading Volume With Binary Options?
For binary options traders, there are two ways of trading the volume that relate to the two ways of measuring the volume:
- You can trade the volume directly,
- You can trade the volume indirectly through technical indicators.
Let’s look at each of these possibilities individually.
How To Trade The Volume Directly With Binary Options
This is the simplest and most direct way of trading the volume. You can trade two kinds of signals:
- Single candlesticks. When a single candlestick shows a significantly higher volume than the candlesticks surrounding it, trade a high/low option in the direction of the prediction created by the candlestick. Traders who like to take risks if they can get a higher payout can also invest in a high/low option. Choose your expiry based on the type of candlestick that you are trading.
- Multiple candlesticks. When all or most candlesticks that point in one direction show a much higher volume than the candlesticks in the other direction, there is a good chance that the market will move in the direction of the higher volume. During sideways movements and most market situations, this indication helps you understand where the market will go. You can trade this prediction with a high/low option. Use a longer expiry than with the first expiry.
As you can see, this strategy is simple. Identify the direction that shows the higher volume and invest accordingly – that is it.
How To Trade The Volume Indirectly Through Technical Indicators
This strategy largely depends on the indicator that you choose as the basis, but we will once again stick with the most popular volume-based technical indicator, the MFI.
As we already explained, the MFI creates a value between 0 and 100. You can find profitable trading opportunities when the MFI drops below 20 or rises above 80. These areas are considered overbought (over 80) or oversold (below 20), which makes a return into the normal area likely.
As soon as the MFI crosses the back into the normal areas, you know that there must be momentum and potential for a long movement, which is why now is a great time to invest.
- As the MFI crosses the 80-line downwards, invest in falling prices.
- When the MFI crosses the 20-line upwards, invest in rising prices.
Typically, you would use a high/low option for this trade. You could also use a one touch option, but this would be a very risky strategy you should only trade with the help of additional indicators that can predict the length and the strength of the movement.
Trading Volume Conclusions
The volume is highly relevant to binary options traders. It can help you identify profitable trading opportunities and avoid bad ones, which can combine to significantly increase your profits.
You can trade volume directly, by analysing single candlesticks or multiple candlesticks, or indirectly through technical indicators such as the MFI. Either way, the volume should be a helpful addition to your trading strategy.
If you still need the right broker to trade this strategy, take a look at our broker top list.