Volume and Volatility Analysis

Volume as a measure of participation

Volume records the number of units transacted during a given period. Its analytical value lies in the confirmation it provides for price movement. A breakout above a resistance level accompanied by rising volume indicates that a substantial number of participants are transacting at the new price, which supports the continuation of the move. The same breakout accompanied by declining volume suggests that a small number of orders has moved price through a thin order book, a condition in which price frequently returns to its prior range.

Statistically, breakouts on low volume fail more often than they succeed, and the failed breakout is itself a recognised pattern in which the participants who bought the break are obliged to close their positions, accelerating the return into the range. Volume does not indicate direction; it indicates the weight of participation behind whatever direction price has taken, and thereby the probability that the movement is sustained.

Tick volume in over-the-counter markets

The spot foreign exchange market has no central exchange through which all transactions are routed, and consequently no single authoritative record of volume exists. Trading platforms, including MetaTrader 5, instead display tick volume, which is the number of price changes recorded during each period. Tick volume is a proxy: it counts the frequency of quotation updates rather than the quantity of currency exchanged.

Despite this limitation, tick volume correlates reasonably well with actual transaction activity, because periods of heavy trading generate more frequent price updates than periods of inactivity. It is sufficient to distinguish an active session from a quiet one and to identify whether a breakout has occurred during a period of elevated activity. For exchange-traded instruments such as equity index futures, genuine transaction volume is available and should be preferred where the platform provides it.

Measuring volatility with Average True Range

Average True Range (ATR) is the most widely used practical measure of volatility. The true range of a single period is the greatest of three values: the difference between the period's high and low, the difference between the high and the previous close, and the difference between the low and the previous close. The ATR is the average of the true range over a specified number of periods, conventionally fourteen. It is expressed in the price units of the instrument and states how far the instrument typically moves in one period.

The principal application of ATR is in setting the distance of a stop-loss order. If EUR/USD has a daily ATR of 70 pips, a stop-loss placed 15 pips from the entry lies well within the ordinary daily fluctuation of the instrument and will frequently be executed by routine price movement unconnected with the validity of the trading idea. A stop-loss set as a multiple of ATR, for example 1.5 times the daily ATR, adjusts automatically as volatility rises and falls, whereas a fixed pip distance does not.

Volatility-adjusted position sizing

The practical consequence of measuring volatility is that it determines position size. The monetary amount at risk on each trade should remain constant, as a fixed percentage of account equity. When volatility increases, the stop-loss must be placed further from the entry in order to remain outside normal price fluctuation, and the position must therefore be smaller so that the monetary risk is unchanged. When volatility falls, the stop can be placed closer and the position may be larger for the same monetary risk.

A trader who maintains a fixed lot size irrespective of conditions is, without intending it, accepting two or three times more monetary risk during volatile periods than during calm ones. The relationship between the three variables is fixed: the risk in money is chosen in advance, the stop distance is determined by volatility and market structure, and the position size is whatever value satisfies the first two. The lesson on position sizing methodology sets out the calculation in full.

• Monetary risk per trade: held constant as a percentage of equity.
• Stop-loss distance: determined by volatility and market structure.
• Position size: calculated so that the first two conditions are both satisfied.

Practical considerations on the trading platform

ATR and tick volume are available as standard indicators in MetaTrader 5 on desktop, web, iOS and Android. The minimum trade size on Onys Kapital accounts is 0.01 lot, which permits the position size to be adjusted in fine increments as the ATR-based stop distance changes. Volatility also affects transaction costs: spreads on both the Standard and Pro account types are variable and tend to widen during periods of elevated volatility, particularly around scheduled economic releases.

A trader should therefore expect the cost of entering and exiting a position to be higher precisely when volatility is highest, and should incorporate this into the assessment of whether a trade offers adequate reward for its risk. The trading conditions page on the Onys Kapital website sets out the applicable spreads and contract specifications for each instrument.