Volume Matters
By Daniel Chesler, CMT, of Chesler Analytics*
Posted: Nov 12, 2010
Volume represents the number of shares or contracts transacted over a given period in a security or instrument. The subject of volume has been covered extensively over the past century by analysts such as Harold Gartley, Edwards and Magee, and John Murphy to list only a few. Unfortunately, all too often, traders and investors fail to give volume the full credit it deserves as an important indicator. Just as many also fail to understand and properly interpret price / volume relationships.
The first and most important concept to understand about volume, is that change in volume is an "effect" while change in price, in the majority of cases, is the "cause." This is easily understood from an emotional / behavioral perspective. For traders on the wrong side of the market, the motivation to trade, to stem losses, increases non-linearly as prices move against their position.
On the other hand, traders on the correct side of the market are compelled by greed to trade, by adding to existing positions as prices move in their favor. For traders with no position in the market, price change causes anxiety due to envy and a sense of "missing out" on profits. For those who base their trading and investment decisions on fundamental factors, ultimately. price movement above or below perceived "value" serves as the trigger to buy or sell.
Thus, it is price change that drives interest and participation in a market while a relative absence of price change tends to have the opposite effect. This context gives us a better understanding of the dynamics behind changes in volume.
The study of price and volume relationships in the stock and commodity markets actually dates back even further than the work of the technical analysts mentioned previously in this article, back to the earliest "tape readers" of the late 1800s (the ticker machine was introduced in 1867). From all of these cumulative observations and studies, some generally accepted theories have emerged:
By Daniel Chesler, CMT, of Chesler Analytics*
Posted: Nov 12, 2010
Volume represents the number of shares or contracts transacted over a given period in a security or instrument. The subject of volume has been covered extensively over the past century by analysts such as Harold Gartley, Edwards and Magee, and John Murphy to list only a few. Unfortunately, all too often, traders and investors fail to give volume the full credit it deserves as an important indicator. Just as many also fail to understand and properly interpret price / volume relationships.
The first and most important concept to understand about volume, is that change in volume is an "effect" while change in price, in the majority of cases, is the "cause." This is easily understood from an emotional / behavioral perspective. For traders on the wrong side of the market, the motivation to trade, to stem losses, increases non-linearly as prices move against their position.
On the other hand, traders on the correct side of the market are compelled by greed to trade, by adding to existing positions as prices move in their favor. For traders with no position in the market, price change causes anxiety due to envy and a sense of "missing out" on profits. For those who base their trading and investment decisions on fundamental factors, ultimately. price movement above or below perceived "value" serves as the trigger to buy or sell.
Thus, it is price change that drives interest and participation in a market while a relative absence of price change tends to have the opposite effect. This context gives us a better understanding of the dynamics behind changes in volume.
The study of price and volume relationships in the stock and commodity markets actually dates back even further than the work of the technical analysts mentioned previously in this article, back to the earliest "tape readers" of the late 1800s (the ticker machine was introduced in 1867). From all of these cumulative observations and studies, some generally accepted theories have emerged:
- Healthy price action exhibits expanding volume on price's movements in the direction of the underlying trend and lower volume on contra-trend movements.
- A form of buying known as "accumulation" and a form of selling known as "distribution" occur when one side of the market accommodates the opposite side without demanding a material concession in price level. This can be seen when a relatively high number of shares or contracts change hands with little net price movement. Accumulation buying and distribution selling can occur over long periods or, as is often the case, over just one "key" day.
- A struggling market is indicated by low volume during an advance or decline that re-approaches a prior resistance or support level. This is, essentially, a type of non-confirmation, akin to a momentum divergence, and serves as a warning of an impending reversal (either up or down).
- A market preparing itself for a breakout or breakdown from a trading range or chart pattern normally exhibits declining volume just prior to the breakout or breakdown, with noticeably higher volume after the breakout or breakdown.
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