One of the most fundamental yet often overlooked indicators is volume of trading. This seemingly simple term plays a crucial role in the development of effective trading strategies. In this article, we'll take a deep dive into the concept of volume, its importance in algo trading and how traders can use volume to enhance their trading strategies.
What is Volume in trading?
Volume refers to the number of transactions made on a financial instrument over a given period of time. In other words, it measures the amount of trading activity. Each transaction requires a buyer and a seller, and volume reflects the level of activity and interest at a given price.
Take your algo trading strategies to the next level
Use our strategy database to develop quantitative strategies faster.
✔️ Research papers
✔️ Trading rules
✔️ Performance metrics
✔️ Python code
Why is volume important?
Volume is often seen as an indicator of the strength or weakness of a price movement. A price movement accompanied by high volume is generally considered more robust and likely to continue than the same price movement accompanied by low volume.
Volume can also be used to predict market momentum. A sudden rise in volume can indicate increased interest in a financial instrument and may precede an upward or downward trend.
Although volume is a valuable tool, it does have its limits. High volume does not always guarantee a specific direction of price movement. What's more, in less liquid markets, volume can be less reliable as an indicator.
Volume and algo trading
In algo trading, volume is used to reinforce or invalidate other signals. For example, a bullish price movement accompanied by increasing volume could indicate a solid uptrend, while the same price movement without a significant increase in volume could be viewed with skepticism.
Many algorithmic trading strategies incorporate volume as a key factor. For example, traders can use volume to confirm reversals or breakouts of support or resistance levels. A sharp increase in volume can indicate increased interest from traders, which can reinforce the validity of a trading signal.
Studies, such as those by Kang, Kim and Lee, have shown that option volume can predict future stock returns. They have also found that the information contained in options markets is incorporated relatively slowly into stock prices. This suggests that volume can often precede price movements, offering traders a potential opportunity.
Volume is a mainstay of trading, offering valuable insights into market activity and interest. For those new to algo trading, incorporating volume into their strategies can offer a significant advantage. As always, it is essential to combine volume with other indicators and methods to develop a complete and effective trading strategy. For traders seeking to master the art of algorithmic trading, the understanding and effective use of volume is a must.
💡 Read more:
- Trading strategies papers with code on Equities, Cryptocurrencies, Commodities, Currencies, Bonds, Options
- A curated list of awesome libraries, packages, strategies, books, blogs, and tutorials for systematic trading
- A bunch of datasets for quantitative trading
- A website to help you become a quant trader and achieve financial independence