Volume Spread Analysis (VSA) in trading: what is it and how does it work?

In the following article, we are going to discuss Volume Spread Analysis (VSA), an advanced technical analysis tool that focuses on the relationship between trading volume and asset price. This tool, developed by Tom Williams, seeks to decipher the force behind supply and demand in the market, providing traders with a deeper insight into price movements.

volume spread analysis

What is Volume Spread Analysis (VSA)?

The Volume Spread Analysis (VSA) is a technical analysis tool that studies the relationship between trading volume and asset price. VSA is based on the idea that volume is an indicator of the strength of supply and demand, suggesting that changes in trading volume can often precede and predict future price movements. This relationship, known as “The Negotiation Volume and Price Relationship,” is crucial for traders using VSA to understand market trends and make informed decisions.

Tom Williams was the founder of TradeGuider Systems Software and initiator of the Volume Spread Analysis (VSA) methodology.

vsa volume spread analysis

What should be considered in VSA?

Let's look at the points to consider when applying a VSA-based strategy.

Volume analysis

In VSA, volume refers to the number of shares (or contracts) traded during a specific period. It's a measure of market activity and liquidity.

Volume Spread Analysis may initially appear complex, but it primarily focuses on a couple of key concepts:

  • Climactic volume: This refers to any volume that is significantly higher or stands out on the volume histogram compared to the surrounding volume levels. It's important to note the relative nature of climactic volume; it's not about an absolute number, but rather about how it compares to the recent volume history.
  • Notable absences of volume: Just as important as high volume is the noticeable lack of volume in certain areas. This should be interpreted in conjunction with price action, specifically the price range of the period and where the price closes within that range.
stock market

For example, in the chart above, we should pay attention to how the climactic volume correlates with a decrease in price action in the lows that the S&P 500 marked after the bear market of 2022.

Regarding the type of charts, several types of bars may be used:

  1. Standard OHLC bars: These bars represent the Open, High, Low, and Close prices for a given time period. They provide a full view of the price action during the period, which is crucial for VSA as it involves analysing the spread (difference between high and low) and the close in relation to the volume.
  2. Candlestick bars: Similar to OHLC bars, candlesticks show the same price information but in a format that many traders find easier to interpret for patterns and market sentiment.
  3. Close-only bars: These bars represent only the closing price of each period. While less common in VSA, they can be used for a more simplified analysis. However, they omit the high, low, and opening prices, which are important in traditional VSA for evaluating the price spread.

How does VSA work in trading?

VSA is a reactive, rather than predictive, system. It doesn't attempt to forecast price direction.

Instead, it analyses market behaviour through volume and price action. The occurrence of Climactic Volume suggests the involvement of large participants or ‘smart money' in the markets. These entities have significant capital, capable of influencing price movements, at least temporarily. They typically build or exit positions gradually, often in specific price areas. This activity is reflected in the charts by noticeable spikes or drops in volume.

In VSA, it's essential to understand that while these market players can influence prices, their control is not indefinite; it's usually confined to certain periods.

These participants often align their actions with the prevailing market trend, reacting to, rather than controlling, overall market conditions.

Spread patterns

Each pattern in VSA must be evaluated within its broader context. A single bar or candlestick alone can provide limited insight. It's crucial to seek coherence between the price range and volume. For instance, a bar with a narrow spread but unusually high volume indicates significant activity and warrants closer examination to understand the underlying market dynamics.

ftmo spreads

As you can see in the chart above, there is a very narrow bar with notable volume. Also, observe how the previous upbars trade less and less.

This is just a clue. We can observe how the process of trend reversal is not a single event and it happens progressively. Often, it will be necessary to refer to larger-scale charts to confirm the direction.

It is good practice to combine the use of this tool with other indications based on price action that help to provide context. And of course, the support and resistance levels, where you must pay more attention to the price action and volume because these are areas where unusual activity may appear.

vsa trading uk

Chart analysis

The chart analysis is a crucial part, to understand the VSA. In general, this is what you should look for:

Weakness appears in bullish bars and strength appears in bearish bars.

And there are a series of laws in the market that help to understand what's happening:

  • Law of supply and demand: The more interest in an asset, the more buyers are willing to acquire the asset at higher prices, and vice versa.
  • Law of cause and effect: Every movement in a liquid and regulated market has a cause. An upward trend appears after the accumulation of the asset at lower prices, and vice versa.
Trading analysis uk
  • Law of effort vs result: It states that there should be a correlation between the effort (volume) and the result (price movement). If there is a significant effort, evidenced by a high volume, but the price does not move accordingly, it suggests a discrepancy.
What is the VSA method?

For instance, if a large volume (effort) does not lead to a proportional price movement (result), it may indicate that the opposite of the apparent trend could be happening. This could be a sign of strong buying or selling interest absorbing the volume without a clear price move, suggesting potential accumulation or distribution by large players in the market.

VSA Trading Platforms: Your Top Options for Success

Looking to add Volume Spread Analysis (VSA) to your trading toolbox? Here's the lowdown on the top platforms:

  • MetaTrader 4 & MetaTrader 5: Popular for their advanced charting, these platforms let you build custom VSA indicators for in-depth analysis.
  • TradingView: User-friendly and packed with VSA indicators & widgets, TradingView makes visualizing volume & price a breeze.
  • NinjaTrader: Futures and forex traders, rejoice! NinjaTrader offers powerful analysis tools and the ability to backtest VSA strategies.

👉 Have a look at our NinjaTrader vs Atas

Plus, these platforms often have supportive communities to share insights and strategies with fellow VSA enthusiasts.

Ready to level up your trading? Find the VSA platform that fits your style and start analyzing like a pro!

VSA trading strategy: Summary

You will find this approach to be the cornerstone of all your trades. However, movements aren't always clear, and often you'll find yourself waiting for certain confirmations. This methodology allows you to work in any timeframe. In higher timeframes, you'll take time to find the optimal ‘setup', requiring patience. In intraday trading, it will likely enable you to find daily trades.

Reading the charts gives you the opportunity to understand what happens behind the scenes. Your job is to interpret where the forces of supply and demand balance, and which of these two is more likely to emerge victorious, influencing the subsequent price movement.

Pros: You are using an efficient tool, seeking to align with large market players who have more information and greater economic power to sway the market. You don't need complex platforms or sophisticated indicators.

❌ Cons: Not all assets display the total trading volume, leaving you with partial information.

Often, due to the inertia of the current trend, the price gives many signals that might suggest a turnaround. But a real confirmation of the price action is needed. Patience and experience will often help you avoid premature entries.

Complement VSA with other technical tools

Here are some other key technical analysis tools:

  • 👉 Price By Volume (PBV): This approach is grounded in the belief that the transaction volume of an asset is a crucial indicator of its price movement. Under this methodology, a high volume accompanying a price change signals strong conviction in that direction, suggesting the trend is likely to continue. Conversely, if a price change occurs with low volume, it might indicate a lack of conviction, pointing to a potentially weak or unsustainable trend. Traders, therefore, use volume as a tool to gauge the strength of a trend and to anticipate potential market reversals or continuations.
  • 👉 Elliott Wave Theory: The Elliott Wave Theory, developed by Ralph Nelson Elliott in the 1930s, is based on the premise that financial asset prices follow repetitive and predictable patterns. Elliott identified a cycle of waves that are part of the mass psychology of investors.
  • 👉 Fibonacci Sequence: The Fibonacci sequence is a widely used tool in technical analysis to identify support and resistance levels in the prices of financial assets. This mathematical sequence is derived from the observation of natural patterns.
  • Moving Averages
  • Commodity Channel Index (CCI) indicator
  • Intraday Momentum Index (IMI)

FAQs

How does VSA help traders?

VSA helps traders identify potential market direction by examining whether demand (buying pressure) or supply (selling pressure) is dominating, based on the analysis of volume, price spread, and closing prices.

Can VSA be used in all markets?

VSA is primarily used in markets where accurate volume data is available, such as stocks, futures, and forex markets.

How does VSA differentiate between bullish and bearish signals?

VSA looks at volume and price action to differentiate signals. For example, high volume on up bars (closing near the high) can be bullish, while high volume on down bars (closing near the low) may be bearish.

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