What is the quantity of shares or crypto-currency exchanged during a given period? The analysis of volumes is often neglected nowadays in favor of technical indicators and oscillators of all kinds. It is true that the volumes displayed on your trading platform or at your broker are those executed at your broker himself and therefore do not represent the total quantity of assets that are traded on the market. However, this gives a general indication of the current state of the market and allows us to have a small representation of the liquidity or not of an asset.

 

The volumes

They represent the sum of all securities that are traded on a given time unit. Be careful, these are only the securities actually traded (and not just the orders placed).

During a resistance breakout, for example, market participants will often look to see if this breach is followed by high volumes. If the break occurs with low volumes, it may only be a false break, a bull trap and prices may fall back quickly.

On the other hand, if this break is followed by high volumes, it reassures the participants: everyone sees the break, and everyone enters. The bullish trend has a good chance of being valid.

A real explosion in volumes can be the case if all “laggards” see the upward trend and enter. Indeed, significant peaks in volumes may be due to the closing of long positions (buyers collect their gains and some sellers enter the market).

This is usually where you start cashing in your profits or going back up your stops. (for more details see ”market makers strategy”). It is common for a trend to reverse just after several particularly high-volume peaks.

Surprisingly, if a bullish trend needs “validation” when volumes increase significantly, this is absolutely not true for a bearish trend.

To explain this phenomenon, it is necessary to compare the volumes to the throw of a ball: to climb, the ball needs an impulse (bullish volumes) when to fall back, the ball does not need any help. In a bearish trend, prices can fall simply because of a lack of buyers.

 

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Bullish breakout and then bearish breakout were both supported by high volumes, which approved their validity.

 

The decline in volumes (and therefore in the interest of market participants) is often reflected in a decrease in volatility. As the particularly quiet period that crypto-currencies experienced in October / November 2018 when crack was closer to the end than the beginning.

 

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We can see that in October / November the volumes evolve well below their average 20 days (in yellow) which was an indication of the temporary lack of interest in crypto-currencies: they were not very exchanged. This coincides with the tightening of the Bollinger bands and is indicative of almost non-existent volatility. And this raises various problems, particularly in terms of liquidity.

 

Liquidity

Liquidity is probably one of the most important things in trading. An asset is said to be “liquid” if it can be bought or sold easily and without major impact on the price. As you will have understood, an APPLE share is very liquid because it is very easily exchangeable (quickly, simply, for a minimal fee) while a real estate asset is much less liquid (slowness of the process, price, administrative procedures…).

This is an extremely important aspect for traders to be able to buy and resell the stock as quickly as they have bought it.

Imagine for a moment: you enter the market for the purchase of 100 € worth of crypto-currency. The price increases to 120 € in the days following your purchase. Glad to see that you have made a good investment, you want to resell this cryptocurrency and collect your added value. Unfortunately, you can’t find a buyer and your crypto-currency quickly falls back to a lower price than the one at which you bought it. Infuriating, right? This crypto-currency was not sufficiently liquid.

What brings liquidity to a market? Simply large volumes. These are a guarantee of liquidity on the financial markets and the very particular market of crypto-currencies often suffers from this problem: many assets are listed on platforms but are not liquid. Indeed, the smallest cryptocurrencies are traded in very small volumes, making them illiquid and it is difficult, if not impossible to trade. To illustrate my remarks, here is an image that will be better than a long speech:

 

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Example of an illiquid cryptocurrency on Bitfinex in 3 hours: does this make you want to trade it? Not me!

 

Before embarking on trading in a particular cryptocurrency (or any asset), it will be necessary to ensure that it is sufficiently traded on the exchange. Indeed, each cryptocurrency has a different level of liquidity and if some are very liquid, others can be a real desert of liquidity.

Personally, I trade a lot on the Bitfinex exchange and even on a platform as big as this one in terms of volume, the main crypto-currencies are not very liquid on small time units.

–> The liquidity of an asset can be judged by looking at a short time frame. If the graph is clear, it is liquid. If, on the other hand, the graph is hatched, if the candles are flat or very elongated (as seen above), the currency is illiquid, and it can be dangerous to trade it. However, for small amounts, your orders will logically find a counterpart.

 

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Example of low liquidity over 1 minute on Bitfinex (left, NEO) and good liquidity over 1 minute (right, BCH). Comparing this type of liquidity is essential if you want to go intra-day.

 

–> We can also judge the liquidity of an asset by looking at the spread.

The spread represents the difference between the purchase price (bid) and the sale price (ask), it is a differential between two prices. The lower the spread, the greater the liquidity, and the lower the cost of placing orders.

 

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Example of a rather low spread: 1 USD for a BTC at 3450.

 

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On the other hand, a spread of 630 pips (or 0.063 %) on Qtum at the same time.

Needless to say, this spread is simply monstrous… and denotes the very low liquidity on this crypto at this precise time of day

 

Manipulation (Pump & Dump)

Finally, a final problem is emerging regarding the volumes and liquidity of an asset in the cryptocurrency market. We talked about liquidity risk (not finding a buyer or seller who would be willing to buy or sell the asset in question), but another problem is particularly present in the world of crypto: the risk of manipulation. Indeed, very popular on crypto-currencies, the famous ”pump & dump” are created by large players on small crypto (small capitalization).

The process is simple: large players massively buy a cryptocurrency with large amounts of money. Since capitalization is small, these purchases literally make prices explode. Individuals and other uninformed investors will see that this crypto ”explodes” and will all rush to it causing many purchase orders. The organizers of the pump & dump simply resell their crypto massively dropping prices.

Proper handling.

This is feasible because of some very small capitalizations and is simply not possible on very large capitalizations. This is why I strongly recommend that you always favor the largest cryptocurrencies in your trading, they are less prone to suffer from any liquidity problems and will be less likely to be manipulated.


Want to learn more? The following articles may be of interest to you

Dow’s theory

Parabolic Stop And Reversal

On Balance Volume (OBV)” 

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