Almost everything that technicians use in plotting a specific security involves either the price itself or a statistical variation on it. Volume can offer a new dynamic in our interpretation of crowd psychology. Therefore, analyzing volume trends gives us a better understanding of how and why price patterns work. In effect, the study of the characteristics of volume gives greater depth to the weight-of-the-evidence approach described earlier. Volume not only measures the enthusiasm of buyers and sellers, but also is a variable that is totally independent of price. In this chapter, we will discuss some general principles of volume interpretation, and in Chapter 26 some individual volume indicators. We are beginning our volume coverage at this point, as it is a basic building block of price patterns, in a similar way to the concepts of support and resistance, peak-and-trough analysis, and trendlines. At the end of this chapter all the basic building blocks will have been covered, leaving us prepared to tackle the subject of price patterns head on.
Volume studies offer three major benefits:
1. When price and volume patterns are compared, it is important to see whether they are in agreement. If so, the probabilities favor an extension of the trend.
2. If price and volume disagree, this tells us that the underlying trend is not as strong as it looks on the surface.
3. Occasionally, price action offers mild signs of an impending trend reversal, but volume can throw up characteristics of its own that literally shout this message. In such cases, a study that was limited to price action would fail to uncover a really good and obvious warning or opportunity.
1. The first and most important principle is that volume typically goes with the trend. It is normal for activity to expand in a rising market and to contract in a declining one (see Figure 7.1). In this sense, volume is always interpreted in relation to the recent past.
FIGURE 7.1 Volume Goes with the Trend
Comparing twenty-first-century 1 billion-plus share days on the New York Stock Exchange (NYSE) with early twentieth-century levels of 5 or 6 million is of little help. Such a comparison reflects institutional, not psychological, changes. Volume is higher today because of more companies being listed, the advent of derivatives, lower commissions, and so forth. On the other hand, a 3-billion-share day this week compared to a recent 1.5-billion-share day last month is relevant, because it shows a significant change in activity over a period in which major institutional changes will be nonexistent.
We know that when prices move in trends, this does not occur in a straight line. Instead, the price works its way up and down in a zigzag fashion. Volume trends are similar. On the left side of Figure 7.2, for instance, the solid arrows indicate an expanding volume trend and the dashed ones declining trends.
FIGURE 7.2 Volume Moves in Trends
It is apparent that the level of activity does not expand in every period. There are quiet periods and active ones, but the general thrust is up. It, too, is irregular. When we talk about volume rising or falling, we are usually referring to its trend. It is normal for such trends to be interrupted by aberrations in volume levels. Volume trends, like price trends, can be intraday, short, intermediate, or long, depending on the nature of the chart.
The amount of money flowing into a security must always equal the amount of money flowing out. This is true regardless of the level of volume. Consequently, it is the degree of enthusiasm of buyers or sellers that determines the course of prices. If buyers are bullish, they will raise their bids until their demands are satisfied. If sellers react to bad news, they may panic, pushing prices down sharply, but at all times, the amount of a security being sold is equal to that being purchased.
2. The combination of rising volume and rising price is normal. It indicates that things are in gear. Such a state of affairs has no forecasting value, except to imply that it is likely that a negative divergence between price and volume lies ahead.
3. Volume normally leads price during a bull move. A new high in price that is not confirmed by volume should be regarded as a red flag, warning that the prevailing trend may be about to reverse. In Figure 7.3 the price peaks at point C, yet the average volume reached its maximum around point A.
FIGURE 7.3 Volume Leads Price in an Uptrend
Such action is normal; the declining volume peaks warn of underlying technical weakness. Unfortunately, there are no hard-and-fast rules about how many divergences precede a peak. Generally speaking, though, the greater the number of negative divergences, the weaker the underlying technical picture. Also, the lower the peaks relative to each other, the less enthusiasm is being generated, and the more vulnerable the technical position becomes, once buying dries up or selling enthusiasm intensifies. A new high that is accompanied by virtually no volume is just as bearish as a new price high with virtually no upside momentum.
An example is shown in Chart 7.1 for Aligent Technology, where you can see that the volume clusters gradually become smaller as the price rallies. Eventually, this negative technical characteristic is confirmed as the price violates the 2010–2011 up trendline in early July 2011.
CHART 7.1 Aligent Technology 2010–2011
4. Rising prices accompanied by a trend of falling volume (Figure 7.4) is an abnormal situation. It indicates a weak and suspect rally and is a bear market characteristic.
FIGURE 7.4 Rising Prices and Falling Volume Is Bearish
When it is recognized, it can and should be used as a piece of evidence pointing to a primary bear market environment. Volume measures the relative enthusiasm of buyers and sellers. When it shrinks as prices rise, the advance occurs because of a lack of selling rather than because of sponsorship from buyers. Sooner or later, the trend will reach a point where sellers become more motivated. After that, prices will start to pick up on the downside. One clue is provided when activity increases noticeably as the price starts to decline. This is shown in Figure 7.5, where you can see that volume starts to pick up as the price starts a sell-off.
FIGURE 7.5 Falling Prices and Rising Volume Is Bearish
In such situations, it is not necessary for volume to expand throughout the decline, as it does in this example. It could be that it picks up for two or three bars just after the peak. In fact, this would be a more typical situation.
Figure 7.6 shows how the volume configurations change between a bull market and a bear market.
FIGURE 7.6 Volume Characteristics Change in Bull and Bear Markets
Chart 7.2 shows the final rally being accompanied by a trend of declining volume for Coors. When the lower trendline is violated, volume picks up noticeably. In this instance, we have one bearish volume configuration that is instantly followed by another.
CHART 7.2 Coors 2000–2001
Chart 7.3 shows several bear market rallies in which the rising price trend is accompanied by declining volume for Radio Shack.
CHART 7.3 Radio Shack 2000–2001
5. Sometimes both price and volume expand slowly, gradually working into an exponential rise with a final blow-off stage. Following this development, both volume and price fall off equally sharply. This represents an exhaustion move and is characteristic of a trend reversal, especially when supported by a one- or two-bar price pattern (discussed in subsequent chapters). The significance of the reversal will depend upon the extent of the previous advance and the degree of volume expansion. Obviously, an exhaustion move that takes 4 to 5 days to develop will be nowhere near as significant as one that develops over a matter of weeks. This phenomenon is termed a parabolic blow-off and is featured in Figure 7.7.
FIGURE 7.7 Parabolic Blow-Off
Unfortunately, exhaustion, or blow-off, moves such as this are not easy to define in the sense that it is possible to construct clearly definable trendlines or price patterns. For this reason, it is usually not possible to spot the terminal phase until a period or so after volume and price have reached their crescendos. Furthermore, because of their nature, parabolic blow-offs are quite rare.
Chart 7.4 uses Newmont Mining to demonstrate a classic example of an exponential increase in both price and volume that ends in tears in the form of an abrupt reversal in late September 1987. We see another in Chart 7.5 featuring Amrep Ordinary.
CHART 7.4 Newmont Mining 1986–1987
CHART 7.5 Amrep Ordinary 2003–2009
6. A selling climax is the opposite of a parabolic blow-off. It occurs when prices fall for a considerable time at an accelerating pace, accompanied by expanding volume. Prices typically rise after a selling climax. The low that is established at the time of the climax is unlikely to be violated for a considerable time. I emphasized the word unlikely because there are no guarantees, just a strong probability. Clearly, a selling climax is likely to be more of an indication of a final short- or intermediate-term bottom in a bull market. A price rise from a selling climax is by definition accompanied by declining volume. This is the only time when contracting volume and a rising price may be regarded as normal. Even so, it is important to make sure that volume expands on subsequent rallies, as indicated in Figure 7.8.
The termination of a bear trend is often, but not always, accompanied by a selling climax. Unlike parabolic blow-offs, which are quite rare, selling climaxes appear on the charts far more often and are, therefore, quite a common technical phenomenon.
In Chart 7.6, we see a selling climax develop in 2010 for Andarco Petroleum. This is then followed by a rally and a subsequent test on lower volume. Note how volume declines on the rally, a perfectly normal characteristic following a selling climax.
CHART 7.6 Andarco Petroleum Ordinary 2009–2012
7. When prices advance following a long decline and then react to a level at, slightly above, or marginally below the previous trough, this is a bullish sign if the volume on the second trough is significantly lower than the volume on the first. There is an old saying on Wall Street, “Never short a dull market.” This saying applies very much to this type of situation, in which a previous low is being tested with very low volume. Such a situation indicates a complete lack of selling pressure (see Figure 7.9).
FIGURE 7.9 Look for Low Volume when Testing Lows
8. A downside breakout from a price pattern, trendline, or moving average (MA) that occurs on heavy volume is abnormal and is a bearish sign that confirms the reversal in trend (Figure 7.10).
FIGURE 7.10 Rising Volume on a Downside Breakout Is Bearish
When prices decline, it is usually because of a lack of bids, so volume contracts. This is normal activity and does not give us much information. However, when volume expands on the downside, it is because sellers are more motivated, so the decline, other things being equal, is likely to be more severe.
9. When the price has been rising for many months, an anemic rally (Figure 7.11) accompanied by high volume indicates churning action and is a bearish factor.
FIGURE 7.11 Churning Is Bearish
An example featuring Dresser Industries is shown in Chart 7.7.
CHART 7.7 Dresser Industries Petroleum 2007–2009
10. Following a decline, heavy volume with little price change is indicative of accumulation and is normally a bullish factor (Figure 7.12).
FIGURE 7.12 Accumulation Is Bullish
11. Record volume coming off a major low is usually a very reliable signal that a significant bottom has been seen. This is because it indicates that an underlying change in psychology has taken place. Such reversals in sentiment are usually of a primary trend magnitude. Examples in the U.S. stock market developed in March 1978, August 1982 and 1984, and October 1998. A similar pattern also developed at the 1987 low in bonds and eurodollars. This is not an infallible indicator, though, because record volume was achieved in January 2001 for both the NYSE and NASDAQ, yet this did not turn out to be the final low for the bear market, which was achieved over a year later in October 2002.
12. When volume and price expand at a sharp pace, but short of a parabolic blow-off, and then contract slightly, this usually indicates a change in trend. Sometimes this is an actual reversal and at other times a consolidation. This phenomenon is featured in Figure 7.13 and represents a temporary exhaustion of buying power.
FIGURE 7.13 Extremely High Volume After a Sharp Advance Indicates Exhaustion
It is associated with several one- and two-bar price patterns, discussed in later chapters. The example shows the price eventually selling off, but it could just as easily have risen. All the volume crescendo is telling us is that buyers are exhausted and we should expect a pause. When that buying is exceptionally heavy, a more bullish extreme in sentiment is indicated and is more likely to be followed by an extended period of price erosion, as shown in Figure 7.13.
13. When the price experiences a small rounding top and volume experiences a rounding bottom, this is a doubly abnormal situation, since price is rising and volume is falling as the peak is reached. After the peak, volume expands as the price declines, which is also abnormal and bearish. An example is shown in Figure 7.14. An example featuring Microsoft is featured in Chart 7.8. Note how the letter n characterizes the price action, whereas the volume configuration is closer to letter u.
FIGURE 7.14 Watch Volume on Rallies and Reactions
CHART 7.8 Microsoft 2007–2009
14. When the price volatility shrinks to almost nothing and volume does the same, this indicates total disinterest. When the situation is eventually resolved, this is often followed by an above-average price move. In Figure 7.15, for instance, price and volume fall to the kind of levels where the slightest movement in either direction will signal a dramatic price movement.
FIGURE 7.15 Exceptionally Low Volume Is Very Bullish when Confirmed by Price and Expanding Volume
In this case, the down trendline is violated on the upside and volume explodes; so, too, do prices. Generally speaking, the quieter the price and volume action relative to the preceding downtrend, the more explosive the confirmed subsequent rally is likely to be. In this case, “confirmed” means some kind of a price trend reversal accompanied by expanding volume.
A very narrow balance between buyers and sellers is certainly apparent in Chart 7.9, which features ICIC Bank.
CHART 7.9 ICIC Bank 2008
Note the shrinking volatility of the price activity and the accompanying trend of lower and lower volume. The balance between buyers and sellers is extremely fine as we roll into early September. Then the price breaks to the downside and volume expands. That’s the signal for an above-average price decline
None of the indicators used in the technical arsenal are guaranteed to work every time. This is certainly true of volume characteristics. However, when volume is used in combination with price characteristics in pattern interpretation, trendline violations and moving average crossovers it greatly enhances the probability that a specific setup or formation will “work.” As we discuss specific price examples in subsequent chapters, the basic volume principles described here will be expanded to suit individual cases.
You will also be able to appreciate at this point that most of the time volume as an indicator is not telling us very much. However, when it does speak and is confirmed by other indicators, a loud message is indeed given.
1. Volume is a totally independent variable from price.
2. It is normal for volume to go with the trend. When these characteristics are present, they have little forecasting value.
3. When volume trends are moving in a direction opposite to that of price, this is abnormal and either warns of an impending trend reversal or emphasizes the significance of any breakout.
4. Volume trends experience exhaustion phenomena. These are called parabolic blow-offs at tops and selling climaxes at lows.