The Hidden Strengths of Volume Analysis

8/6/2019 The Hidden Strengths of Volume Analysis

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The Hidden Strengths of Volume Analysis

Nick Radge

The power of correct volume analysis cannot be overlooked.

Unfortunately the ability to read volume correctly is not readily discussed

or freely available. Off-the-cuff remarks such as, increased volume on

advances is bullish and increased volume on declines is bearish are bantered around but thats as far as it goes. The correct use and

application of volume can make for some quite startling insights into

price action, especially when one is swing trading or leaning against

support and resistance points or zones of confluence.

I set up my charts with a couple of extra volume measures. I use a normal

volume histogram that can be found with almost all software packages.

However, if there is a larger volume spike skewing the ability to read the

volume properly I will edit the data accordingly. Next I add a 10-day

moving average of the volume. This gives me a guide as to what is below

average or above average volume on any given day. Lastly I add in a 2-standard deviation of the 20-day volume average. Essentially this is like

the upper Bollinger band of the volume average. This shows me whenultra-high volume occurs.


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Figure 1: Chart Setup for Volume Analysis

With these added extras we can quickly gauge the personality of the

days volume as well as benchmark it against the surrounding volume.

The exact volume reading is not important. The concept of relativevolume is the key.

Im going to make reference to The Smart Money throughout this article.

The definition I use for the Smart Money is:

A group of professional users that act in unison at very specific levels andpoints of time to change the order of supply and demand.The Smart Money are the ones who constantly buy the lows and sell the

highs. Let me say that this is not a bunch of traders ringing around

attempting to manipulate the price. We dont need to know who or whybut these are the people we wish to follow. We do so by watching their

footprints and their footprints are show within the daily volume. The

Smart Money will show their hands by selling into strength and buying

into weakness. Now because the Smart Money can change the order of


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supply and demand we can therefore ascertain that strong price actionmay in fact contain weakness and weak price action may in fact contain

strength. I appreciate that goes against most things youve ever learnt

about volume but its important to keep that thought in the back of your

mind. Increased supply and therefore weakness may occur during price strength. Increased demand and therefore strength may occur in priceweakness.

The first thing to understand about volume is that its not just the volume

by itself were interested in. A major misconception is to think that for

every buyer there is a seller and in turn volume is null and void. If thatwere really the case then prices would simply not move. What drives

prices is the fear and greed of the buyers and sellers. Its therefore the

relationship and interaction between volume and price that shows us what

is really occurring in the market. Think of volume as the effort of one

side and the price activity as the result of those efforts. If sellers are

desperate to exit then they will be more inclined to sell at the bid rather

than sit back on the offer. If there is not much buying demand below the

market then prices are going to be driven lower until those sellers are

fulfilled or are unwilling to pursue prices any lower. Conversely, if

buyers are desperate they will buy the offer and not sit on the bid. If

buyers are desperate and there is not much supply above the market thenyoure going to see prices move up until those buyers are fulfilled or

unwilling to pursue prices any higher.

The mantra of volume analysis is:

What is the result of the effort?

The most basic example of a volume/price relationship pattern is a

straightforward blow-off top or bottom. As technicians we all know what

these are and we also know what they tend to mean. Figure 2 shows a

perfect recent example of a blow-off bottom in Lihir Gold (LHG).


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Figure 2: Typical blow-off low in LHG

The gap opening on that low day means sellers were indeed desperate.

There is no other way to account for that gap except simple selling

pressure. They over-ran all buyer demand until they were fulfilled. Theyeven managed to keep pushing prices lower. But remember above I

suggested that demand strength occurs in price weakness? LHG had

certainly been declining up until that point. So if there were no demand

strength, how could prices rise from thereon?

The demand strength is shown by the effort and the result. Effort wascertainly very high because volume was very high, in fact ultra high. This

means a substantial number of transactions took place between buyers

and sellers. But what is the result of that effort? The result of all that

effort is that the market closed on its highs for that day which means that

buyers have clearly over-powered the desperate sellers. When a lot ofeffort or a lot of volume takes place we know the Smart Money is

involved because they are the big players and they are the ones that can

change the course of supply and demand. This is a prime example where

the Smart Money has decided that LHG is a value buying proposition and


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they move into the market to absorb the selling volume. They are thestronger party. Its the weaker hands capitulating. This is why I said that

demand strength will appear on weakness. If the Smart Money have

absorbed all the selling volume and the sellers are fulfilled, how can

prices go any lower? They cant is the basic answer. And if prices cantgo lower then they will tend to go back up because now there is nooverhanging supply capping the market.

Lets look at the exact same concept but without the blow-off. Remember

the core thinking; increased supply and therefore weakness may occur

during price strength and what is the result of the effort?

Again well use LHG but note this time the absolute high bar is a very

small tight range and not the standard blow-off that were normally used

to seeing.

Figure 3: The Smart Money appears at the absolute high

Firstly the volume shows itself as extremely high, almost ultra high. We

therefore know there are a lot of transactions taking place and in turn a lot


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effort being put into the day. So what is the result of that effort? A verytight range with the close on the lows and below the open. What does it

suggest? Clearly that the sellers have overpowered the buyers. The buyers

must have been desperate because prices have been gapping higher and

they were most likely desperate from probable good news.

Ever heard the truism, buy the rumour, sell the fact? Do you ever

wonder why prices go down after a positive announcement? Do you think

the Smart Money new the facts or the good news beforehand and is why

theyre already long? I think so. So when the good news is announced to

the market all the weaker hands jump in and start buying and the SmartMoney take the opportunity to offload their positions into the demand

strength.

Look at that LHG chart again in Figure 3. Prices were already trending

higher. The Smart Money has already bought because they knew what

was coming. When the announcement came they took their profits and

sold their positions to all the latecomers. The force of buying from all the

latecomers was large. We know this because the volume was high. But

the force of the Smart Money selling and standing firm in the face of

large buying was even larger and is why the days range was so small. If

the Smart Money thought prices were going to travel higher, then theywould not be selling and we wouldve had a wide ranging up day on light

volume. But because the Smart Money knew that prices would mostlikely not go any higher, they stood their ground and simply offered their

supply into the buying from the weaker hands.

Lets think about what all those weaker hands are thinking at the close ofthat session. Good news has been announced. I bought the stock

accordingly but its now closed below where I purchased it so Im

wearing a loss immediately. You can see them almost scratching their

heads! Because the Smart Money had absorbed all the buying demand

there is now no follow through buying demand. All the weaker hands areall of a sudden slightly nervous. Any slight weakness will see them exit

their positions. They wait a day or so in wonderment but look at what

occurred on the 3rd

day after the high. A down day on increasing volume.

Those weaker hands that bought the highs have had enough and are

getting out whilst they can. They walk away with yet another loss butnone the wiser for why prices couldnt go higher on the good news.

So whenever you see a very tight range at new highs or lows that is

accompanied with ultra high volume, you know the Smart Money is


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trading the other way. They are large enough to change the trend so youdbetter listen.

These are two simple examples of reading volume correctly. There are

many more to be aware of, but remember the mantra, what is the resultof the effort?

The best book on volume/price analysis is Master the Markets by Tom

Williams who is the Richard Wyckoff of the modern era. Its 190-pages

packed with volume and price characteristics and I rank it as one of my

top-5 trading books ever. I am such a believer in this book and theinformation that it holds that a complimentary e-version is given to all my

subscribers.

Nick Radge has been trading and investing for 20-years. He nowpublishes Australias premier Technical Analysis market letter for stockand CFD traders wanting to learn to trade using price and volume

without the hindsight. He holds an Australian Financial Services Licenseand can be contacted via www.thechartist.com.au
http://www.thechartist.com.au/http://www.thechartist.com.au/


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The Hidden Strength of Volume Analysis Part 2

In the last journal I discussed two examples of how and why volume canshow the changing face of supply and demand. When the order of supply

and demand is change we will get a change in market direction,sometimes a significant change in trend or otherwise some degree ofretracement of the prior move. We will continue on from that discussionand show larger periods of transition which can lead to quite substantialturning points in the major trends. These can be easy to identify, but dorequire some patience. If you did not read the prior article it would now

be worth reviewing that before going on. Please refer to the July/AugustJournal, specifically pages 24 through 27.

Lets firstly take a look at the bigger picture for a stock that is currently inthe headlines for all the wrong reasons; AWB Limited.


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Since early 2006, the price of AWB has been in a downward spiral. Thestory that eventually came out suggested AWB was doing some bad

business against the UN sanction in Iraq. The initial shock sent the shares plunging by 18% in a single week. This is a sure sign of a change in

sentiment and its not exactly rocket science to know there must havebeen some kind of bad news that changes the outlook.

But what is important here is that this significant sell off is actually thefirst sign that strength may start to appear in the near future. As Idiscussed in the first article, demand strength actually starts in priceweakness and here is a sign of capitulation. A wide ranging bar onincreased volume is a sign of panic and when we see panic we canusually expect that a bargain could be in the offering, but this is where the

patience is required. What we usually start to see after capitulation is atransition from sellers to buyers. This transition has two importantcharacteristics; firstly it takes some time and secondly prices do tend todrift lower. Lets zoom into the AWB chart at Area 1 and also add ourvolume indicators.


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Bar 1 is the capitulation; a very wide ranging bar and ultra high volume.Remember that ultra high volume is signalled when the volume histogram

penetrates the volume Bollinger band. Bar 2 gaps lower but closes on theweeks high and does so on high volume. This is a sign that the Smart

Money is interested in buying. There is no other way that prices can closehigher on increased volume if buyers were not involved. Bar 3 howevershows sellers returning; a push lower, a low close and another increase involume. Bar 4 is the turning point and is a sure sign that buying interest isoccurring. This is the time to start thinking that this market will turnhigher soon. This bar shows a move to new lows but a complete rejection,that is, a high close and very high volume. Were seeing the SmartMoney taking positions, even though the stock is drifting lower. Nowtake a close look at bars 5 and 6. What happens? Essentially they areinside days with a slight downward bias but look at the volume? There isnone. Volume has dried right up. What this means is that sellers are done;theyre exhausted. Those that wanted to sell have either been fulfilled ordo not wish to chase prices any lower. Bar 7 sees another probe lower,another high close and yet again a rapid increase in volume. Combinedwith bars 2 and 4, both of which show back ground strength, this iscontinued evidence that the stock is being accumulated. Its only a matterof time before enough of the supply has been accumulated that prices willstart to rise again.

For the next 2 months AWB rallied 34% off that exact low. The firstsigns of upward price momentum would be the signal to initiate longs.We have the Smart Money footprints in the volume so we just need totime the entry for our own comfort. Take a look at the bars from thatlow. All down bars had low volume; all up bars had high volume. Therewas a specific transition from sellers to buyers which led to a reasonable,albeit unsustainable, price rise.

The following chart shows that advance in more detail. Bar 8 was a very

promising bar indeed; a wide range higher, a high close and a goodincrease in volume. With the high close we can deduce that buyers hadthe control. Bar 9 is an important bar for current longs. It shows anattempted push higher, a reasonably tight range but more importantly aweak close and solid increase in volume. This is the first time that sellershad come back to the market. Now these sellers can originate from twosources; either profit takers that bought at lower levels, after all, it was arapid rise in quick time which will always create profit taking; or it isvery old longs who were waiting for the evitable bounce to get out of

their positions. Were not to know which, but what we do know is thatselling has emerged and that caution is required.


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Bar 10 shows a rise into new recent highs but a close on the absolutelows. This is of paramount importance what does it mean? Bar 9showed sellers because we had a weak close yet on high volume.Immediately following, Bar 10 shows a low close on low volume, whichsuggests buyers have disappeared. If buyers have gone who is going tosupport the market if those sellers from Bar 9 decide to chase priceslower? Nobody. If there is no buyer demand or buyer support then prices

have the risk of falling until that buyer demand comes back again. Andthat exactly what has occurred.

Lets move forward to Area 2 where prices fall through the early lows setin Area 1. Please refer to the following chart.


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Bar 11 makes a low at $3.57, has a close off the lows and shows a mildincrease in volume. The $3.57 level is important because the lows madeon Bar 7 were at $3.55 which is where the prior buying entered themarket. It could be easily argued that those buyers back then should beseen again at those levels. So the minor increase in volume and a closeoff the weeks lows is an important sign when they correspond with anold low to the left. Prices continue to drift lower as weaker hands stop out

below the lows made earlier in the year. However, although Bar 12 closesoff the lows its quite a low volume bar not quite conducive to asignificant change in supply and demand. Prices move sideways on lowvolume until we see Bar 13 take out the major lows and close on thosenew lows. The difference here is that volume is poked up through thevolume Bollinger band suggesting ultra high volume. Again, this is

probably a sign of capitulation as its a clear break to new lowssuggesting sellers in control. But look at bar 14. Is that not the very samething we started to see on Bar 2 of the first chart? A wide ranging bar

down, a high close and massive volume. In fact this could almost beconstrued as a blow-off low, although the range is not quite wide enough


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for a text book example of such. Nonetheless it does show that buyers arein again. The following bar is a down close but volume has dried up sellers exhausted? Bar 15 takes out the lows of bar 14 by 2c beforerallying hard and closing high. Again, volume was very high suggesting

that buyers are stepping up to the plate.

Interestingly enough this current price/volume activity is occurringimmediately before the findings of the Cole Inquiry. Does the SmartMoney know the outcome already? Remember in article 1 I suggestedthat good news tends to precede a fall and that bad news a rally? Wouldthe release of the report be considered potentially damaging news? Yes itcould. We know the old adage that things look the worst at the low and

best at the top but it is possible that volume is suggesting that the worst isover and that quite possibly were going to start to see prices trade higher.

The very last bar on this chart was the release of the report to Parliament.We have a probe above the small ledge but a lower close than the openand a rapid increase in volume. This is not an immediately good sign

because it does suggest strong selling. Therefore wed need to assess thevolume/price relationship of the coming few weeks to better measure thewillingness of the buyers seen at bars 14 and 15.

All in all, the relationship and volume/price is a very strong measure of

subtle changes in supply and demand and can lead to both minor andmajor changes of trend. Therefore its beneficial for both traders andinvestors alike to really understand these nuances so they can better

position themselves for new trades or offer warning signs of currenttrades.

Nick Radge has been trading and investing for 20-years. He now

publishes Australias premier Technical Analysis market letter fro stockand CFD traders wanting to learn to trade using price and volumewithout the hindsight. He holds an Australian Financial Services Licenseand can be contacted via www.thechartist.com.au
http://www.thechartist.com.au/http://www.thechartist.com.au/

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The Hidden Strengths of Volume Analysis