The VSA (Volume Spread Analysis) was developed by Richard D. Wyckoff in 1911 and is characterized by its discordance with market analysts who trade using only the graphic patterns. Wyckoff believed that simple mechanical or mathematical analysis techniques had no chance of winning against the judgments of an experienced trader.
The VSA was later perfected by Tom Williams, a former stock market professional in the 1960s and 1970s, who developed the importance of the price spread in relation to volume and closing price.
In order to be able to carry out the VSA, a forex trader only needs a histogram showing the trading volumes. For forex markets this is a real problem, as, unlike stock markets, actual volume data is not available. Therefore, a forex trader is forced to analyze the volume based on each tick.
The volume of the forex market is represented by the amount of activity of each bar or candlestick. Large professional traders usually enter the market if there is a lot of trading activity. Each scenario can have implications for the supply/demand ratio, thus helping the trader to determine a likely market direction in the short to medium term.
In technical terms, the VSA aims to capture the differences between supply and demand that are essentially created by the main forex operators: professional traders, institutions, banks, market makers. The activity of these operators is clearly visible on a graph for those who know how to read it.
The VSA studies the interactions between three variables on a graph, to determine the balance between supply and demand, as well as the likely short-term direction of the market. The three variables are: volume quantity on a price bar; price difference or range (upper and lower); closing price.
Using these three variables, an experienced trader is able to understand if the market is in one of the following four phases:
Accumulation (purchases of professionals at wholesale prices)
Mark-up (bullish movement)
Distribution (sales of professionals at retail prices)
Mark-down (bearish movement)
The meaning and importance of the volume are usually underestimated by most beginners. Instead, volume is a very important component of a chart’s technical analysis. It indicates the amount of transactions that occur on the market and the price range shows the movement with respect to it. However, a market can be bullish on high or low volumes, prices can evolve in a horizontal range or even drop on equal volumes.
Forex markets move based on the supply and demand of currencies. If there are more purchases than sales, a currency appreciates. If there are more sales than purchases, it depreciates. But, for a currency to appreciate, purchases are not the most important factor. In order for a real bullish trend to occur, there must be a lack of sales (distribution) orders.
Most forex traders completely neglect that significant purchases occur during the accumulation phase. These purchases actually appear on a chart as a bearish candlestick with a spike in volume. The VSA teaches that power in a market is evidenced by a bearish candlestick and vice versa by market weakness, evidenced by a bullish candlestick. A conclusion exactly opposite to what most beginners think. For a real downward trend to occur there must be a shortage of purchase orders. The only operators on the market who are able to inject such a level of purchases are professional and institutional investors, who, however, have already positioned themselves on the sale side, during the distribution phase. Sales by professionals are identified on a bullish candlestick chart with a significant peak volume. Since purchases are limited, the price continues to drop until the mark down is over. Professional traders buy during sales caused, for instance, by the announcement of bad news, which incentivize the mass investors (flock) to sell at a loss. Professionals’ purchases are evidenced by candlesticks or bearish bars.
A professional is able immediately to recognize that a bar closing in the middle of his range with a large volume means that a transfer is occuring from the professionals to the flock, with the latter positioned on the wrong side of the market. Professionals sell at retail (distribution phase) after purchasing at wholesale (accumulation phase).