Short and medium term Bitcoin prices are driven by market sentiment. Thus Bitcoin traders commonly rely on technical indicators more so than long term fundamentals. A useful but sometimes perilous technical indicator for Bitcoin is one that tracks trading volume. Volume indicators for trading Bitcoin include the following: on balance volume, the accumulation/distribution line, money flow index, Chaikin oscillator, Chaikin money flow, and ease of movement.
What Does Bitcoin Trading Volume Tell You?
If you are trading alt coins, trading volume is a good indicator of the viability of the token. Bitcoin is an established cryptocurrency so viability is not the issue. By knowing how much Bitcoin trading is going on every day you have an idea of the current degree of interest in buying and selling this token. High trading volume in any market generally indicates that more buyers are coming in and more buying is taking place. It can also mean that an underlying asset is in trouble and the price is going to fall. In addition high trading volume also indicates sufficient liquidity so that you are unlikely to get trapped in a position if the market falls.
Bitcoin Trading Volume Risks
There is one big risk in relying on trading volume indicators with Bitcoin. It is the high incidence of Bitcoin wash trading. Wash trading is typically done to manipulate the market. Traders sell and then immediately repurchase Bitcoin. This gives the appearance of much more interest in trading the token than actually exists. When other traders are fooled into thinking that there is more interest in buying Bitcoin they can assume that the price is going up. So they buy and do indeed send the price up. Because there is no underlying reason for this to happen the price goes back down again when the Bitcoin wash trading stops. While Bitcoin volume indicators can be very useful tools, traders need to be aware of this risk.
Using On Balance Volume for Trading Bitcoin
On balance volume uses trading volume to predict changes in the prices of stocks or cryptocurrencies. When the closing price of Bitcoin is higher than the previous day, on balance volume is the previous day’s number plus the current day’s volume. When the price goes down it is the previous day’s volume minus the current day’s volume. When the closing price is the same as the previous day, the on balance volume number stays the same. The rationale for this indicator is that it helps see how trading on large investors and traders differs from that of so-called mom and pop investors. The indicator is meant to help indicate market momentum upward or downward.
Accumulation/distribution Line in Bitcoin Trading
This indicator is like on balance volume in that it tracks volume and price. It is used to help determine how strong a trend is. It does this by looking for differences between price and volume flow. It gives you a line on the chart where a rising line confirms an upward price trend while a falling line indicates a downward trend. When a trader follows this indicator for several days it may be sufficient time to determine if temporary high trading volume such as from wash trading was distorting the market.
Using Volume Indicators to Make Sense of Bitcoin Prices
Bitcoin tends to fluctuate a lot. The rationale for using a volume indicator is to see just how many traders are propelling those price changes. When there are a lot of individuals buying Bitcoin, it generally indicates that the price is heading up and it will continue to do so. When the price goes up or down and trading volume is very low a trader needs to be cautious about jumping into the market.
SlideShare Version – Volume Indicators for Trading Bitcoin