Volume, its importance, relation with price, signals explained

What is Volume?

Volume means amount of contracts that were traded for a stock (or any other financial asset like Future, commodity etc) in the defined period of time.

Use of Volume in Technical Analysis:
Volume is used to confirm strength in current trend and is an indicator to identify trend reversal. Any price trend supported with volume movement is considered as reliable. The higher the volume the bigger market participation is which means a larger mass is validating price movement and it will take much stronger news to change the direction of the trend.

When Volume Precedes Price:
Technical Analyst carefully monitor volume movement of stock. Volume is one of the very few leading indicator. In lot of scenarios volume gives a heads up of price movement. Below are two examples of it.
a. Price volume divergence, as described in following section.
b. When stock is range bound for long time and suddenly there is small but consistent increase in volume activity without much change in price indicates that smart investors have started accumulating the stock and up trend is about to start.

Price Volume Divergence

Price Volume Divergence is defined as when price is making higher high but volume is falling indicates strength in upward movement is weakening and a trend reversal is imminent. It means broad market participation do not agree with the upward trend. It may be safe to exit such stocks.

If the stock you are monitoring has traded with low volume on a day then it may be worthwhile to see broader markets volume to confirm. It could be result of holiday season either locally or globally or market is expecting some big news.

Just by picking on one day poorer volume may lead to error. Its often better to let volume trend form before taking the call.

Volume & Support/Resistance

• If volume starts to decrease towards important support and resistance means that probability of support/resistance holds is high.
• If support/Resistance is broken with low volume then it may considered as false move.
• If volume towards support suddenly jumps and price not going down means bottom has reached.
• If volume towards resistance suddenly jumps and price not moving up means top has reached.
• When price moves above Resistance with high volume means trend reversal and uptrend is likely.
• When price moves below Resistance with high volume means trend reversal and downtrend is likely.

How To Use Volume For Stock Trading?

• Price volume negative divergence- As explained earlier.
• Volume pattern towards major support & resistance- As explained earlier.
• When market is moving high and price is rising means momentum is intact. Entering such script is considered to be safer. On the days when price falls/retreats the volume should also be low. This would mean that even with price fall market participants are not willing to exit.
• When stock in uptrend suddenly drops by 5-10 % with huge volume means trend reversal may happen.
• In a sideways market with low volume and price range a sudden price change with volume rise is considered as beginning of new trend. Its especially important to note that only price change without volume may mean false signal.
• When stock is in down trend a sudden price rise with volume spike is considered as trend reversal.
• When Stock is falling with high volume then it means downward momentum is intact. Its best to avoid any long position here
• When stock in downtrend and a sudden price rise by 5-10 % with huge volume indicates trend reversal.

Chart Pattern & Volume:
Many chart pattern like Head & Shoulder, Double Top etc. uses volume to confirm formation of the pattern. If volume flow is not in sync with the price flow then these patterns are considered as unreliable.

Volume Based Indicators
There are many Volume Based Indicators such as: Money Flow Index, On balance volume, Accumulation/Distribution and many more.

Warning

Technical Analyst without using volume can yield undesired results. An individuals decision can affect price of stock traded with low volume and hence its reliability can be questioned. Not all price movement is preceded by volume.

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