Chapter 7: Basic Characteristics of Volume

Introduction & Overview

“Volume is one of
the technical
analysis indicator”.

“Volumes = No of Lots traded

(say in a day)”

Other Technical Indicator

Technical Indicators…
Its about the Price & Volume
and some technical indicators.

Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 11-5

Basic to Charting:
What’s in the charts:

SHARE
PRICES

VOLUMES
= lots traded

Historical

Indicators

TIME
 What is Volume?

Volumes = No of Lots traded (say in a day)

Basic characteristics of volume

• 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.

• 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.
Revisiting Chap 3 @ Dow Theory: 4. Price/Volume Relationships Provide
Background
“Price/Volume Relationships Provide
Background”
The main signals for buying and selling are based on the price
movements of the indexes. Volume is also used as a secondary indicator
to help confirm what the price movement is suggesting.

Volume should:
• increase when the price moves in the direction of the trend &
• decrease when the price moves in the opposite direction of the
trend.
In an uptrend:
a) volume should increase when the price rises and fall when
the price falls. The reason for this is that the uptrend
shows strength when volume increases because traders
are more willing to buy an asset in the belief that the
upward momentum will continue.
5 b) Low volume during the corrective periods signals that
4
most traders are not willing to close their positions
because they believe the momentum of the primary trend
will continue. 2 3
5
Conversely, if volume runs counter to the trend, it is a sign of weakness 1
in the existing trend.
For example, if the market is in an uptrend but volume is weak on
the up move, it is a signal that buying is starting to dissipate.
If buyers start to leave the market or turn into sellers, there is
little chance that the market will continue its upward trend.
The same is true for increased volume on down days, which is an
indication that more and more participants are becoming sellers
in the market.

Revisiting Chap 3 @ Dow Theory:

“Price/Volume Relationships Provide
Background”
The main signals for buying and selling are based on the price movements of
the indexes. Volume is also used as a secondary indicator to help confirm
what the price movement is suggesting.

Volume should:
• increase when the price moves in the direction of the trend &
• decrease when the price moves in the opposite direction of the trend.
In an uptrend:
a) volume should increase when the price rises and fall when the
price falls. The reason for this is that the uptrend shows
strength when volume increases because traders are more The normal relationship is for volume to expand on rallies and
willing to buy an asset in the belief that the upward contract on declines.
momentum will continue.
b) Low volume during the corrective periods signals that most If it becomes dull on a price advance and expands on a
traders are not willing to close their positions because they decline, this is a warning that the prevailing trend may soon be
believe the momentum of the primary trend will continue. reversed.

Conversely, if volume runs counter to the trend, it is a sign of weakness in
the existing trend.
For example, if the market is in an uptrend but volume is weak on the
up move, it is a signal that buying is starting to dissipate.
If buyers start to leave the market or turn into sellers, there is little
chance that the market will continue its upward trend.
The same is true for increased volume on down days, which is an
indication that more and more participants are becoming sellers in
the market.
This principle should be used as background information only, since
the conclusive evidence of trend reversals can be given only by the
price of the respective averages.
According to Dow theory, once a trend has been confirmed by
volume, the majority of money in the market should be moving
with the trend and not against it.
Volume and the technical indicators that are derived from it are
undoubtedly some of the most powerful tools at the disposal of
proponents of Dow Theory.
Benefits of Volume Studies
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.

1) If price and volume disagree, this tells us that the:

underlying trend is not as strong as it looks on the surface.

1) 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.

Benefits of Volume Studies

What can volume tell
us? Analysis

Based on the chart below, after the stock broke above the resistance level at
Volume confirms the
1 trend & reversal point.
about RM2.27 (which then became the support level) and touched at RM2.61, it
started to lose ground. At the same time, the volume declined as well which
indicated a weak downtrend.

Volume confirms chart
2 patterns- Triangle.
The volume indicator is also used to confirm the chart patterns, such as head and
shoulders, triangles, flags and other patterns. As for this case study shown in the
chart, the pattern of the recent share price performance is a triangle.
Currently, the share price is trading at the support level; and based on the RSI
indicator, it is reading at 30%. When the RSI crosses above the 70% level, the
stock is considered overbought, and when the RSI is crosses below the 30%
level, the stock is considered oversold. To interpret, the RSI indicator reading
below the 30% level is a buy signal, especially when the indicator is turning up
from bottom. The recent downtrend of the stock price performance coupled with
declining volume, oversold signal and trading at support level may represent a
buying opportunity.

However, if the stock price cannot hold at the support level of RM2.27 and break
below with increasing volume, this may not be a good sign. If that is the case, the
Volume confirms the
stock may enter a bearish period. Look out for a turning point that may represent
“the study of the characteristics of volume gives
3 support & resistance
level & trend. a trading opportunity. As always, it is best to confirm buy/sell signals with other
indicators.
greater depth to the weight-of-the-evidence
approach”.
Principles of Volume Interpretation
(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 (Figure 7.1).
In this sense, volume is always interpreted in relation to the recent past.

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.
(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 (refer figure 7.3).
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.

Divergence
=

Price Up, but

Volume Down

(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.

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 volume 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.
 (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.

(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).
 (8) A downside breakout from a price pattern,
trendline, or moving average (MA) that occurs on
heavy volume is abnormal and is bearish sign that
confirms the reversal in trend (Figure 7.10).

(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.

Volume up but the price does not really move!

(10) Following a decline, heavy volume with

little price change is indicative of
accumulation and is normally a bullish
factor (Figure 7.12).

(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.
(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.

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.
(Crescendo definition = the highest point reached in a
progressive increase of intensity)

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, the volume expands as the price

declines, which is also abnormal and bearish. An
example is shown in Figure 7.14.

(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.
These are only rough guidelines, and in the
final analysis, it is a judgment call based on
experience; common sense; a bit of intuition;
and perhaps most important of all, a review of
other factors such as volume, support and
resistance principles, etc.

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.”