Inside a Volume Divergence

Nov 8, 2008: 12:02 PM CST

Much has been made about the recent rally into resistance on lower volume, and the subsequent sharp correction following Tuesday’s election.  Let’s step inside this situation for clues on how volume could have helped you anticipate a reversal… or at least suspected that ‘things weren’t quite right’ with the recent rally.

Let’s step inside the Dow Jones Index on the 30 min chart:

Price began a large momentum burst on October 28 which was a counter-trend rally that lasted until November 4th, taking the DIA from $83 to $96 – a large jump – in a matter of days.

What was volume saying to us at that time?  Volume – participation – was NOT confirming these higher prices, as you can see each day’s activity slowly trailed off until reaching a low on November 3rd, one day before the swing high in price appeared.  A negative momentum divergence also accompanied higher prices, which was a further non-confirmation of bullish strength.

As price broke the 20 and then 50 period Exponential Moving Averages, volume began to trend higher as price began its down-swing to the $87 level.  The green arrow represents incresing volume on declining prices, which serves as a ‘confirmation,’ or more specifically, volume was increasing in the direction of the price movement.

A “non-confirmation” by volume occurs when volume is declining in the direction of price movement.  It’s not so much an “up or down” thing, but moreso “is the volume trend rising and falling, and what might that say about the possible future direction?”

Generally, in a strong up-trend, we would expect volume to be rising as well as price travels higher which indicates that more people/funds are participating, increasing demand and pushing price higher.  We would like to see volume decline on sell-offs (counter-swings down) because this would serve as a “non-confirmation” of lower prices, or that people were willing to hold shares and not actively distribute them.

The same is true in a down-trend, in terms of we want to see the volume trend rising as price is making new lows, which serves as a confirmation of these new lows and then trend lower as price rallies in a counter-trend fashion, as the above example shows.

In short, we expect “Volume Goes with the Trend” to the be default expectation, though we’re not always granted this luxury.

The take-away from this example is that price was structurally in a counter-trend rally up on subsequently declining volume, combined with a negative momentum divergence.  That, combined with other analysis, was reason to doubt the short-term sustainability of the higher prices, and caused a higher probability of a downward price move coming.

Volume is only a piece of the puzzle, and by no means can any one piece give an accurate picture in isolation.

16 Comments

16 Responses to “Inside a Volume Divergence”

  1. Anonymous Says:

    hi, which volume indicator works best for you? OBV, Accumulation/Distribution or any other? Thanks

  2. Corey Rosenbloom Says:

    Anon,

    Each have their own peculiarities, but I simply prefer standard volume. The OBV can give divergences and warn ahead of time a little easier, as can Acc/Dist, but I just look mainly at the trend of volume as a sign of strength/weakness.

  3. Anonymous Says:

    Corey,

    You wrote previously, “The Dow is completing an impressive counter-rally to the upside, taking price from a closing low near 8,250 to yesterday’s high near 9,750 for a remarkable 1,500 or 18% rally!”
    Do you have the stat showing the last time did better than 18% for a counter-rally?
    Thanks!

  4. Corey Rosenbloom Says:

    An 18% move is stunning for a counter-trend rally indeed, but the Dow has made larger moves. I study we ran not long ago showed the average counter-trend rally in a downtrend in the S&P 500 was 16% from 1980 to 2007, with four occurrences being greater than 18%. Absolutely impressive, but by no means a record.

  5. Anonymous Says:

    Corey,
    In the study you mentioned, it covered a completed counter-trend rally? And also, do you have the stat showing what happened after the counter-trend rally, that is in term of % again?

  6. Corey Rosenbloom Says:

    It was done using the prices via stockcharts into Excel in terms of swing highs and lows, and trend was identified simply as “higher higher/higher lows” etc. It simply measured countertrend and trend impulses and had no function of what happened before/after. We designed it solely to determine the averages and standard deviations of moves. I’ll need to modify it and re-run it for more information.

  7. Suraj Says:

    Corey:

    I’ve been an avid reader ever since I came. What indicator are you using for the lower subchart to pickup the divergences?

    Regards

    Suraj

  8. Corey Rosenbloom Says:

    Suraj,

    It’s actually just changing the default MACD indicator in StockCharts to 3, 10, 16 (input in the boxes). This creates the “3/10 Oscillator”.

    In essence, it’s the difference between a 3 and 10 period EMA (black line) which is then smoothed by 16 periods (red line).

    Thank you for the question and for reading!

  9. GuerreroMaguire Says:

    I already diged this my firend.

    Have a nice day
    jimmy clark
    ______________________________________________
    pass a drug test | how to pass drug test | pass drug testing

  10. KingBacami990 Says:

    i would love to read more from you on this

    Thanks
    james orel
    ______________________________________________
    home mortgage colorado | san miguel allende real estate | ps3 repair service

  11. MccallisterBonnerSutton Says:

    i have posted your blog on my site

    Thanks
    james orel
    ______________________________________________
    pet sitting fort worth | watch smallville Online | internet marketing classes

  12. HartmannBentleym80 Says:

    Thanks for such a nice post.

    regards
    hamber grif
    ______________________________________________
    mexico travel deals | san miguel de allende hotels | hotel guanajuato

  13. insulated panels Says:

    This is post to my article site.

    respect
    james kails
    ______________________________________________

  14. insulated panels Says:

    This is post to my article site.

    respect
    james kails
    ______________________________________________

  15. spread betting companies Says:

    I always find divergence hard to trade. Easy to spot after the trade but I am not very good at using it.

  16. Vector Says:

    Forex in my view is a puzzle itself but that does not mean we can’t do it or it’s impossible. It is hard but achievable, so if we are willing to put the hard yard we can walk away with positive results and luckily I use OctaFX broker, so all my new tricks and techniques are allowed here and the conditions makes it a successful adventure. I trade with high lot size which is possible due to leverage level up to 1.500 and smooth trading platform.