Sunday, July 29, 2012

Volume spread analysis, return to price action

I spent a few days learning volume spread analysis (VSA). This is probably one of the most arcane ways of reading charts. The basic principle behind VSA is if you see a candle with low tick volume, the smart money is staying out. If tick volume is high, then the smart money is moving in.

You want to be moving in when the smart money is. If the smart money is staying out, it's because they want a better price before they move in for the kill, e.g. if you see a bullish candle with low tick volume, it suggests the smart money is staying out and letting price rise before they move in to short. However, if you see a bullish candle and tick volume is EXTREMELY high, then it suggests the smart money is actually shorting and trying to hide their selling in a bullish candle.

VSA is much more complex than that. The main difficulty with VSA is subjectivity. How do you define "low" and "high" volume? VSA is its own eco-system, complete with its own chart patterns and terminology. They call pinbars "upthrusts" or "downthrusts"". Dojis are called "no demand" or "no supply" bars. It's a different way of seeing things, but it seems to work for alot of people. However, there seems to be alot of scope for second-guessing and is far too arcane to me.

Price Action

I think my flirtation with mechanical indicator-based trading is over. After testing 30+ systems and their variants, I don't think I will find a highly-profitable system, or at least one that can be traded by a human. I suppose the profit factor from a mechanical system will always be low. This is not a bad thing per se if you can trade with high frequency (i.e. a black box). I'm probably years away from becoming an algo-trader, though.

I spent a few hours today reviewing price action material and assessing historical trades using Forex Tester 2 (highly recommended for backtesting). I'll start posting my historical trades from tomorrow. I have a few ideas up my sleeve which I want to test. 

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