Helpful Information, Articles, Tips and Tricks
for Day Traders.

The Methodology of Volume Spread Analysis

Volume Spread Analysis (VSA) methodology takes a multi-dimensional approach to analysing the market, and looks at the relationship between price, spread or range, and volume. VSA is a proprietary market analysis method conceived by veteran trader, Tom Williams, who was a highly successful member of a professional trading syndicate in the 1960s and also the creator of TradeGuider Systems. The VSA method works particularly well at highlighting the imbalances of Supply and Demand.

VSA builds on the pioneering work of Richard D. Wyckoff, a famous 1920's trader. He based his trading decisions on supply and demand in the markets and how they are inextricably linked to professional activity - 'Smart Money' trading (Wyckoff's principles are still taught at the Golden Gate University in San Francisco). In any business where there is money involved and profits to make, there are professionals. Doctors are collectively known as professionals, but they specialize in certain areas of medicine. The financial markets are no different. The financial markets have professionals that specialize in certain instruments as well: stocks, grains, FOREX, etc. The activity of these professional operators, and more important, their true intentions, are clearly shown on a price chart if the trader knows how to read them. Volume is the major indicator for the professional trader.

Volume Spread Analysis seeks to establish the cause of price movements, and from the cause, predict the future direction of prices. The cause is quite simply the imbalance between Supply and Demand in the market, which is created by the activity of professional operators. It is the close study of the reactions of these specialists, Market Maker Professionals, or ‘Smart Money’, which will enlighten you to future market behaviour.

VSA looks at the interrelationship between three variables on the chart in order to determine the balance of supply and demand as well as the probable near term direction of the market. These variables are the amount of volume on a price bar, the price spread or range of that bar (do not confuse this with the bid/ask spread), and the closing price on the spread of that bar. For the correct analysis of volume, one needs to realize that the recorded volume information contains only half of the meaning required to arrive at a correct analysis. The other half of the meaning is found in the price range. Volume always indicates the amount of activity going on and the corresponding price spread shows the price movement on that volume.

The effect is either a bullish or bearish move according to the prevailing market conditions. The ‘Smart Money’ operating in the markets are very much aware of the emotions that drive YOU, and the uninformed traders or investors, in your trading.

Why do the members of the self-regulated Exchanges around the world like to keep true volume information away from you as far as possible? The reason is because they know how important it is in analysing a market! The significance and importance of volume appears little understood by most non-professional traders. Perhaps this is because there is very little information and limited teaching available on this vital part of technical analysis. To use a chart without volume data is similar to buying an automobile without a gasoline tank.

Where volume is dealt with in other forms of technical analysis, it is often viewed in isolation, or averaged in some way across an extended timeframe. Analysing volume, or price for that matter, is something that cannot be broken down into simple mathematical formulae. This is one of the reasons why there are so many technical indicators; some formulas work best for cyclic markets, some formulas are better for volatile situations, whilst others are better when prices are trending.

Some technical indicators attempt to combine volume and price movements together. This is a better way, but rest assured that this approach has its limitations too, because at times the market will go up on high volume, but can do exactly the same thing on low volume. Prices can suddenly go sideways, or even fall off, on exactly the same volume. So, there are obviously other factors at work.

Price and volume are intimately linked, and the interrelationship is a complex one, which is the reason Volume Spread Analysis was developed in the first place.