Volume in the forex trading market

In forex trading, volume does not refer to the number of trading lots offered or bid, but the number of completed transactions. Therefore for technical traders, volume is a powerful but too often overlooked indicator of market sentiment and therefore currency pair movement.

It’s the volume that provides the forex trading market with its legendary liquidity and depth. So many entities are in the market at any given time—central banks, financial institutions, institutional traders, hedge funds, corporations making international transactions—that no matter when a retail trader seeks to open or close a position, it’s almost a given that the trade will be completed, a counterparty available to fill the order.

But that volume isn’t spread evenly throughout the forex trading day. It varies by market centre, with Asia being the least active, London being the most active, and the North American market somewhere in between. By far the most active portion of the forex trading day is the period when both the New York and London markets are open, with roughly half of all transactions taking place at that time.

There’s something magical about the time slot between 1:00 PM and 2:00 PM GMT (11:00 PM to midnight Canberra time), which coincides with the 9:00 AM opening and first hour of trading in New York City. Regular as clockwork, the highest volume for most currency pairs on any given trading day occurs within that time slot.

This is important because volume is considered the strongest of all possible confirmations for currency pair movement. Low volume equates to a few traders and institutions shuffling lots about. While sharp movements can occur during periods of low volume and liquidity, those moves are suspect because there’s nothing to back them. When volume and liquidity increase, such moves are likely to be overwhelmed and possibly reversed.

But a currency pair movement on high volume makes all traders sit up and take notice. A movement backed by so much capital switching hands, so many orders entered, means the market players have quit analysing and started trading. Such a movement has “legs,” as the saying goes, and has greater potential to drive the currency pair far and fast.

Below is the daily chart of the Euro versus the U.S. dollar, currency pair EUR/USD:

The light blue bearish trendline is drawn from the 3 December swing high at 1.5141. The downtrend paused over the Christmas holidays over low volume, seen as a dip in the vertical green lines at the bottom centre of the chart. A similar dip is seen in early April during the Easter week holidays.

But on the right of the chart, volume surges and the downtrend accelerates as the European debt crisis made itself felt in early May. However, the volume spikes actually coincide with the moves higher, but whether this is short sellers covering their positions and taking profit, or the beginning of a double bottom and potential reversal, has yet to be established.

Forex Traders are warned to monitor their short Euro positions, with increasing volume on rising prices likely to serve as the early warning to exit