Volume Spread Analysis

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Video Transcript:

Hello, traders. Welcome to the fourth module of the Advanced Technical Analysis course: Chart Analysis. In this lesson, we are going to teach you all about Volume Spread Analysis and how to use volume to get a better interest and how to follow smart money using it. Let’s get started.

First of all, what is smart money? When we talk about smart money, we are talking about professional money like big hedge funds and big institutions. And, in order to be truly profitable as an independent trader, you must know where these players place themselves and where their orders are. This is important because if you don’t know this, you might get trapped trying to trade against them, and lets face it guys, your trading account is not nearly as big as a hedge fund’s trading account so you want to follow these big institutions are doing, okay? To follow what these institutions are doing we are going to use what we call the Volume Spread Analysis or VSA.

What is VSA? It’s the story of the supply and demand in the market and how these forces manipulate price. I know manipulation has a negative connotation but in this case it doesn’t. It just means that how supply and demand actually take each other out so they can make price either move up or down. You already understand that a correction occurs because one of these forces has swept the other. Let’s take an example of a down trend. Let’s say that we have arrived at a small or not as important area of support where you will find some demand, okay? If the trader or the trend is strong enough, all the supply will clear these demands and price will start to move lower thus breaking with this area of support. And, this is when we are going to start with the VSA. But, the true importance is to understand the cycle of a directional move, and where to look for entries, and what areas to avoid trading.

Now, there are four phases in a directional move cycle. The first phase is the accumulation, and here is where the smart money jumps in and starts buying. And, in most of the cases, you will not know about this because when the big hedge funds and big institutions start buying, they don’t communicate it openly on the wires. You will only notice this when volume starts to accumulate and price starts to build up. The second phase is the mark up. Here is where big institutions are sweeping the supply and price starts to rise. Then, the third phase is the distribution phase. After the price starts to rise, the general public starts to realize that these big players bought lower so they think it’s a good investment and they want in.

Volume spread analysis

And, what happens in distribution? In the distribution phase, these institutions are already at their target areas so they want to start out unloading their shares, for example. So, when the public or the general public starts to demand these shares, the big institutions will supply them thus taking a profit on their investment, and this is what we call dumb money, jumping in at these levels. At the fourth phase is the mark down. The professional money starts to buy into the general public so they can buy and by doing so, they are taking profit on their positions and price starts to drop. Why does price start to drop? Because, the supply is so big at this level that the man from the general public will not feel it or sweep it so price will start to fall down.

So you don’t want to be dumb money but you can’t be smart money or professional money. All you can do is follow these four phases along with volume to understand to where to buy an asset. Now, let’s get a more visual description of what the four phases are. We start with our favorite of accumulation. Here, you have no idea what the hedge funds and big institutions are doing, and to tell you the truth, the stocks are not in anyone’s radar at the moment. So, the big players are accumulating stock, then price shoots up, and this is what we call the marks up. When price shoots up, all the general public starts to see this and the stock starts to pump in everybody’s radar, and everybody wants to in.

Some people might actually… professional break up traders might get in on this first up move but most of the general public will not because actually, these moves occur in quite a big or very rapid manner. So, when the general public starts to see that the price goes [inaudible 00:06:01] a little bit, they start to jump in and here is where the big institutions that bought down here start supplying to the market so the dumb money can buy here but the supply is so strong, it’s so big, that the demand of the general public can not break through it and price shoots down. This is what we call the mark down. And of course, the dumb money is always a loser in this case and in any case. After the mark down, we have another period of accumulation and this is what we call Buy in the Dip.

This is what we call the second smart money, okay? You see the accumulation. If you could not trade the break out, you don’t buy at the top of the move, you wait for the mark down and you start buying from the dumb money that bought here and wants to sell, okay? So, here’s what happens. Professional money buys here. Dumb money buys here from professional money here. Professional money makes money. Dumb money loses money and you buy from dumb money here, and everybody does before the price starts to shoot up.

So, this is basically what the four phases are and now, we are going to go through an analysis chart so you can see what happens with volume. Okay, this is a daily Amazon chart and back in September 2013, we were in a nice up move that started around $270 per share price level. And as you can see here, we hit an area of resistance and what you see here, you see huge buying at this area of resistance. Now what happens, price moves up $10 or so, and then shoots down. This is the exact scenario that we just saw, okay? Dumb money starts to buy here, boom! And what happens here, you get red candles, of course, red volume and then, you get those green candles where you start to buy, okay?

As you can see here, we had a couple of days with huge gaps in them. I don’t even know if it was because of earnings release or something. I don’t have it on this chart but as you can see, we have huge buy in here at the start of this day, all throughout the day actually, we have a huge green volume bar, almost 10 million shares traded in Amazon. So you can get a perspective, Amazon trades between 1 and 3 million shares per day, sometimes less than 1 million if there is really nothing going on with the stock. But this day, it traded actually almost 12 million shares, which is three or four times more than usual, and price actually rejected this area as you can see here. So, if you were actually trying to get into Amazon you would wait for a small dip, maybe to a previous area of supply so you can actually jump in, which in this case worked.

This is how you actually use the VSA and with the volume chart to see if you are actually in distribution or in accumulation zones.


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Adam is an experienced financial trader who writes about Forex trading, binary options, technical analysis and more.

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