Virtually all technical indicators are a mathematical derivative of price action. Volume analysis opens a completely separate dimension, which addresses the question “To what extent does participation confirm the move underway?” Here are some principles that help guide our thinking as we listen to “The Voices of Volume.”
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 by 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).
Open Interest information is only provided by the Futures and Options Market, though they can assist volume decisions as well.
For an explanation on how to interpret this chart, visit the blog article, “Insights from Volume and Open Interest.“
It is a good idea to display volume bars or other volume indicators on your charts to allow you to go beyond the price dimension and assess participation using the principles of confirmation and non-confirmation.