Learn the Stock Market Lesson – The Purpose of Volume in the Financial Markets

Volume is a significant indicator in technical analysis because it provides important clues about the intensity behind price movements. Volume can be measured by shares, contracts, or dollars that trade hands between sellers and buyers.

Rising volume tends to confirm trends and declining volume brings doubt. If there is a big price movement, the perceived strength of that movement is based on its volume. The higher the volume is at the time of the price move, the more significant and stronger the move is.

Rising volume shows that traders are still coming in, letting the trend to continue. But if traders start to abandon the market, volume falls and the trend is less likely to continue.

Volume During an Uptrend
During an uptrend, volume confirms the price trend if the volume is heavier when the price moves higher and lighter when the price dips. This shows that the buying pressure is greater than the selling pressure, allowing the uptrend to continue.

Volume During a Downtrend
During a downtrend, volume confirms the price trend if the volume is heavier when the price decreases and lighter on bounces. This shows that the selling pressure is greater than the buying pressure, allowing the downtrend to continue.

Trading Techniques

1. When the stock price breaks out from a trading range and if there is a sudden increase on the volume of a stock, it usually indicates the beginning of a trend. Get in on that trend.
2. When a trend is in a well-established move and if there is a sudden increase on the volume of a stock, it usually indicates the end of a trend. It’s probably best if you skip or leave that trade.
3. Divergences between price and volume tend to signify turning, or reversal, points. For example, when the price of a stock rises to a new high but volume shrinks, it shows that the price increase did not attract much interest and a downside reversal is likely. Likewise, if the price falls to a new low and volume falls as well, it shows that the price decline attracted little interest and an upside reversal is likely.

To use more objective ratings of volume, you can study an indicator called Force Index, which was developed by Dr. Alexander Elder, author of the books, “Trading For a Living” and “Come Into My Trading Room.”

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This entry was posted on Friday, August 14th, 2009 at 11:01 pm and is filed under Learn The Stock Market, Technical Analysis. You can follow any responses to this entry through the RSS 2.0 feed. Both comments and pings are currently closed.