Why Volume is Important
Volume is an important aspect of technical analysis because it is used to confirm trends, and chart patterns.
Any price movement up or down with relatively high volume is seen as a stronger, more relevant move than a similar move with weak volume.
Therefore, when I am looking at a large price movement, I also examine the volume to see whether it tells the same story.
For example: a stock runs + 5% in 1 trading day after being in a long downtrend, the Big Q is, is this a sign of a trend reversal? This is where volume helps. If volume is high during the day relative to the average daily volume, it is a sign that the reversal is probably real. On the other hand, if the volume is below average, there may not be enough conviction to support a true trend reversal. So, patience is in order.
Volume should move with the trend. If prices are moving in an upward trend, volume should increase, and vice versa.
If the previous relationship between volume and price movements starts to deteriorate, it is usually a sign of weakness in the trend.
For example: if the stock is in an up-trend but the up trading days are marked with lower volume, it is a sign that the trend is starting to lose its legs and may soon end.
When volume tells a different story, it is a case of divergence, which refers to a contradiction between 2 different indicators. The simplest example of divergence is a clear upward trend on declining volume.
Paul A. Ebeling, Jnr.
Paul A. Ebeling, Jnr
Paul A. Ebeling, Jnr. writes and publishes The Red Roadmaster's Technical Report on the US Major Market Indices, a weekly, highly-regarded financial market letter, read by opinion makers, business leaders and organizations around the world.
Paul A. Ebeling, Jnr has studied the global financial and stock markets since 1984, following a successful business career that included investment banking, and market and business analysis. He is a specialist in equities/commodities, and an accomplished chart reader who advises technicians with regard to Major Indices Resistance/Support Levels.
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