Most traders are aware of the two widely known approaches used to analyze a market, fundamental analysis and technical analysis. Many different methods can be used in each approach, but generally speaking fundamental analysis is concerned with the question of why something in the market will happen, and technical analysis attempts to answer the question of when something will happen.
There is, however, a third approach to analyzing a market. It combines the best of both fundamental and technical analysis into a singular approach that answers both questions of “why” and “when” simultaneously; this methodology is called volume spread analysis. The focus of this article is to introduce this methodology to the trading community, to outline its history, to define the markets and timeframes it works in, and to describe why it works so well.
What is Volume Spread Analysis?
Volume spread analysis (VSA) seeks to establish the cause of price movements. The “cause” is quite simply the imbalance between supply and demand in the market, which is created by the activity of professional operators (smart money). Who are these professional operators? In any business where there is money involved and profits to make, there are professionals. There are professional car dealers, diamond merchants and art dealers as well as many others in unrelated industries. All of these professionals have one thing in mind; they need to make a profit from a price difference to stay in business. The financial markets are no different. Doctors are collectively known as professionals, but they specialize in certain areas of medicine; 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. 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 (see Figure 1). Continue reading »
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