VSA (Volume Spread Analysis) – An Introduction

VSA (Volume Spread Analysis), a method proposed by Tom Williams, is one of the most powerful tools in technical analysis. Also known as Wyckoff VSA, it is based simply on the concept of supply and demand. It analyzes the interrelationship between the volume, price and spread/range of the price bar in a market. The trade positions are taken based on the imbalance of supply and demand in the market. Using VSA along with trend lines helps in taking trade positions confidently.

Before we go into the working of VSA, read the basics of how a Japanese candlestick is formed here.

Following are closely observed in VSA:

• Volume bar at every price candle
• The Range of the price candle (note: the range here is between the candle’s highest price and lowest price and not between the open and close price)
• The closing price of every price candle

VSA seeks to establish the cause i.e. why the price moved the way it moved. In the process, it identifies the imbalances of supply and demand or strength and weakness in any market. It is based on the principle that these movements are caused due to the activities of professionals who deal with huge amounts of money (huge enough to alter the market dynamics). These professionals are called “Smart Money”. The retail investors with comparatively lower amounts simply follow their activities. VSA aims to identify opportunities for retail investors sooner than the rest of the market players.

VSA also strongly believes that volume and price are intimately related. The two must be observed simultaneously along with the price spread because volume only shows half the information. The observation is compared with the previous 2-4 bars for accurate interpretation. VSA is a wonderful method, when used with trend lines, helps in confidently analyzing opportunities for trading in any time frame.

TRADING USING VSA

VSA helps to identify the bullish volume, the bearish volume, Signs of Weakness (SOW) and Signs of Strengths (SOS). Based on these signs and confirmations, a trader understands the activity of Smart Money. A bullish volume is characterized by rising volume bars with rising price candles and the vice versa is true for a bearish volume. While SOW helps in going short, SOS helps in taking a long position.

Sequence example 1: Short Trade Setup

First SOW: End of a rising market

• Price candle on the top of the chart closing at the higher side but with a narrow spread
• High volume
• The market has seen substantial upward movement in the past

Smart Money seems to be willing to supply the market without marking prices higher. This is a bearish action. However, one should wait for confirmation of this action using the following two SOW.

Second SOW: No Demand

• Price candle on top of the chart closing in the middle but with a narrow spread
• Low volume or volume lower than the last two bars
• SOW must be present in the last 2-4 bars for this SOW to become significant

It indicates that Smart Money is not interested in higher prices.

Third SOW: No Demand

• Price candle on top of the chart closing in the middle but with a narrow spread
• Low volume or volume lower than the last two bars
• SOW must be present in the last 2-4 bars for this SOW to become significant

It indicates that Smart Money is not interested in higher prices.

Taking the position

The above sequence confirms the end of an uptrend. The third SOW confirms the opportunity to take a short position in order to gain from the falling market.

Sequence example 2: Long Trade Setup

First SOS: Reversal over 2 bars

• The first price candle at the bottom of the chart should close down. The second price candle opens low and closes above the high of the first price candle showing a wide range.
• The volumes may be higher at this point.
• The market has seen a substantial downward movement in the past.

This pattern suggests that Smart Money is buying at lower prices. The retail traders are panic selling. At the second price candle, the retail traders who had taken a short position need to close their position at a loss. Retail investors also feel they have missed the opportunity to buy at lower prices. However, we must wait for confirmation before taking a position.

Second SOS: No Supply

• Price candle at the bottom of the chart
• Volume lower than the previous two volumes
• SOS must be present in the last 2-4 bars for this SOS to become significant

This indicates a lack of selling pressure in a falling market.

Third SOS: No Supply

• Price candle at the bottom of the chart
• Volume lower than the previous two volumes
• SOS must be present in the last 2-4 bars for this SOS to become significant

This indicates a lack of selling pressure in a falling market.

Taking the position

The above sequence confirms the end of a downtrend. The third SOS confirms the opportunity to take a long position in order to gain from the upward movement in the market.

There are a lot of other VSA strategies that help traders take positions based on Smart Money’s activity in the market. Always remember that every volume bar and the price candle is simultaneously unfolding a story. Carefully observing 2-4 previous bars along with the current bar helps to connect the dots of the story and trade like an expert.