Trading, much like reading a map, relies on accurate signals to navigate market trends. One useful tool in this toolkit is the volume candle, a unique chart type that reveals both price movement and trading volume. While often overlooked, volume candles provide insights beyond standard volume bars, offering a clearer picture of market activity and potential reversals. Here’s everything you need to know to understand and use volume candles effectively.
What are Volume Candles?
Volume candles combine two critical metrics—price and volume—into a single, dynamic chart form. Each volume candle represents both the price range and the level of trading volume over a given period, visually revealing the balance between buyers and sellers. Unlike traditional volume bars that show volume separately, volume candles illustrate this directly on the price chart.
For example, in a volume candle:
Candle Height: Reflects the range between the high and low prices during that period.
Candle Width: Represents the volume, with wider candles indicating higher trading activity and narrower candles showing lower volume.
The key takeaway is that this design enables traders to assess both price action and volume intensity at a glance, offering more context for price trends and potential reversals.
Why Volume Candles Matter
When it comes to market analysis, volume candles help clarify price strength and sustainability. Here’s how they stand out:
Enhanced Trend Detection
Volume candles help you see when high trading activity supports a price trend, increasing the likelihood that the trend will continue. For instance, in an uptrend, a wide, bullish volume candle (higher close than open) indicates strong buyer interest. However, if the price rises on a narrow candle, it suggests limited buying support, which could signal a reversal.Spotting Exhaustion Points
Price exhaustion often precedes reversals, and volume candles can signal when this is happening. Imagine you see a wide, bearish volume candle following a rally; it suggests that sellers have taken control, hinting at a potential trend reversal.Identifying Market Reversals
Volume candles provide clarity in spotting reversals. If prices fall with decreasing volume (narrow candles), it may indicate selling exhaustion, pointing to a possible upward reversal. Conversely, in a downtrend, if the candles suddenly widen with a bearish tone, it signals that sellers are doubling down.
Here's an example of the 6 month performance of Indian Energy Exchange (IEX) using volume candle charts. As you can see, the big red candle highlighted is a visual cue of a significant price movement that changed the course of the bullish trend in one fell swoop.
Compare the previous chart with the last 6 month performance of Campus Activewear. The upward trend appears to be protected by strong bullish sentiment which is reflected in the buying volumes, but not so much in the selling; a sign that the medium-term uptrend may still be intact.
To draw an analogy, think of volume candles as the crowd at a cricket match. When a batsman hits a boundary or scores a six, the crowd’s volume and enthusiasm often reflect the excitement. A packed, loud stadium (wide candle) suggests strong support, whereas a quieter crowd (narrow candle) might indicate low engagement, hinting at a possible shift in momentum of how the crowd feels about the scoreboard.
How to Use Volume Candles in Your Strategy
Here are some practical ways to incorporate volume candles:
Confirming Breakouts
Volume candles can validate or question breakouts. For instance, if a stock breaks above a resistance level on a wide, bullish volume candle, it’s a solid sign that the breakout is legitimate. But if the breakout candle is narrow, it could be a false signal, as the low volume shows limited interest from buyers.Finding Entry and Exit Points
Use volume candles to time entries and exits. In an uptrend, consider entering when you see wide, bullish volume candles that indicate sustained buyer interest. Conversely, if you’re holding a position and see bearish wide candles, it may be time to exit before the downtrend takes hold.Evaluating Market Sentiment
Volume candles offer insights into market sentiment. In sideways or consolidating markets, sudden widening of bullish or bearish candles can indicate a potential breakout or breakdown, depending on the direction of the price action.
Conclusion
Volume candles are a powerful tool for traders who want to understand the underlying dynamics of price movements. By observing the size and color of volume candles, you gain insight into market sentiment, trend strength, and potential reversals, helping you make more informed decisions. In the larger scheme of things, volume candles empowers you to read the market’s story, a little more clearly. Keep in mind that it's not a game changer, but an enhancement in your toolkit to analyze charts.
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