Five Volume Principles to Guide Decisions

May 23, 2008: 9:35 AM CST

Volume analysis is an important part of any trader’s routine, and it’s important to know some key principles about volume to help you arrive at potentially better conclusions or possibilities about future price action.

The most often stated principle is that “Volume Goes with the Trend,” meaning we would expect to see higher volume (relative) occurring during upswings in a rising stock or market (trend), meaning there is increasing interest or an increasing number of participants (buyers) taking part in the move to push prices higher.

Also, for similar reasons, we would expect to see less volume, or a relative decline on volume on price retracements in an uptrend.  These represent logical pauses in a price move and are helpful in keeping prices from being overextended, which could lead to profit taking (another form of price retracement) or possibly short-sellers entering (playing for reversion to the mean).

Here are some other thoughts about volume principles that are based upon the above concept:

1.  Volume can Lead Price

Similar to a momentum divergence, a new high in price needs to be confirmed by at least relative increases in volume, if not new (relative) volume highs as well.  If new price highs are clearly not confirmed by new (relative) volume highs, then this is a warning signal that the new price highs might not last long.  The On-Balance Volume (OBV) indicator is essential for some traders due to its potential to lead price.

2.  Massively Rising Prices with Massive Increases in Volume are often Unsustainable

This goes back to the principle “Trends End in Climaxes” where a sudden rush of euphoria causes all who want to join to be ‘all in’ and thus unable to push prices higher.  As we know, most people are bullish at the top and bearish at the bottom, and when there’s a ‘last ditch effort’ to get into (or out of) a stock, the classic sign is some sort of price blow-off which usually is marked by a stratospheric rise in volume – don’t get caught up.

3.  Price Consolidation after a long Downtrend with Increasing Volume is Bullish

This scenario represents accumulation, in that funds are meeting any selling pressure buy accumulating all available shares, and thus “they know something the mass public doesn’t” or otherwise will catch onto later which could lead to the birth of a new trend.

4.  Price Consolidation after a long Uptrend with Increasing Volume is Bearish

For the opposite reason, after a long rise in price, if price consolidates for a long period of time, yet volume increases, this means that funds are distributing their shares to the numerous buyers who can’t push prices higher, and when the buying pressure eases off, the price would be more likely to fall (or start a new downtrend) than continue rising.

5.  Massive Volume on a New Significant Price Low is Bullish

This signal could represent a capitulation from buyers which is being met by aggressive accumulation by funds or traders, but most likely simply represents a ‘throwing in the towel’ on the part of the buyers who can’t take the pain of lower prices any longer.  Strangely enough, when volume spikes massively on a large volatility down-move in price, this often signals bottoms, especially if the price closes higher on the day or at least closes in the upper range (such as the surge on January 22, 2008).

Listen to the “voices of volume” and what they may be saying about recent price activity, so that you may have a fresh clue about what may be happening in the ever-changing saga between buyers and sellers in the marketplace.

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