Volume : Volume Analysis

Volume

Definition of 'Volume Analysis'

The examination of the number of shares or contracts of a security that have been traded in a given time period. Volume analysis is used by technical analysts as one of many factors that inform their trading decisions. By analyzing trends in volume in conjunction with price movements, investors can determine the significance of changes in a security's price. Volume typically increases as price increases and vice versa; when the opposite occurs, it's called divergence.

Volume is one of the most important technical analysis tools to learn and understand how to apply to price movements. Volume increases every time a buyer and seller transact their stock or futures contract. If a buyer buys one share of stock from a seller, then that one share is added to the total volume of that particular stock. Volume has two major premises:

1. When prices rise or fall, an increase in volume is strong confirmation that the rise or fall in price is real and that the price movement had strength.
2. When prices rise or fall and there is a decrease in volume, then this is interpreted as being a weak price move, because the price move had very little strength and interest from traders.

The chart below of Gold futures shows a strong trend being confirmed by a strong increase in volume:

The chart above of Gold shows that when prices began making new highs, volume increased. As the price of Gold increased, more and more buyers (buying pressure) jumped on board.

Likewise, if prices are heading downward and are making new lows and volume increases, the sellers are becoming more and more interested as price falls (increased selling pressure).

Importance of Volume when Analyzing Price Movements

The following is an extreme illustration of the importance of volume:

• A buyer places a market buy order after hours for 10 shares of stock. The transaction occurs one dollar above the closing price. Therefore, the one dollar price move had 10 shares worth of interest from a buyer.
• A buyer places a buy order for 100,000 shares of stock. This transaction takes place at a price that is one dollar above the current price.

Which example is more bullish? They both increase the last transaction price by one dollar. If a trader didn't use volume, he/she would think that the move was identical from a price chart perspective. Of course, the second example is more bullish because the one dollar more the buyer of the 100,000 shares is willing to pay is significant (the buyer is bullish and is taking a large bet to prove it); whereas, in the second example, 10 shares is insignificant.

Increases or decreases in price along with increased volume isn't always confirming of trend. 

Volume Spikes & Blowoffs

Extreme increases in volume along with extreme rises or falls in price can sometimes be interpeted opposite to regular volume analysis:

• Sharp increases in price and sharp increases in volume can mean bulls have been exhausted, all buyers have bought and there is no one else but sellers; the result is bearish.
• Sharp decreases in price and sharp increases in volume can mean that everyone that wanted to get out of the stock or future has; therefore, there are only buyers left - bullish sign.

The chart below of eBay (EBAY) stock illustrates a volume spike, defined as at least two times the average volume:

Volume extremes occur at bottoms as well, which is shown below in the chart 

A strong understanding of volume is an absolute necessary addition to price analysis. Knowing when price increases or decreases have firm support or knowing when either buyers or sellers have been exhausted is extremely useful when trading. Another way of visualizing volume is Volume Rate of Change  and the Volume Oscillator.

Volume Rate of Change

The Volume Rate of Change indicator measures the percentage change of current volume as compared to the volume a certain number of periods ago. The Volume Rate of Change indicator can be used to confirm price moves or detect divergences. The formula for Volume Rate of Change is expressed below:

• [(Current Volume / Volume n periods ago) - 1] x 100

Generally, the Volume Rate of Change is calculated based on 14-periods for input n, but of course can be modified to any trader preferred period. A chart of the 100 ounce Gold futures is shown below with the 14-day Volume Rate of Change indicator:

 

As the price of Gold was increasing, the Volume Rate of Change indicator was increasing as well, indicating that there was buying interest as prices were rising. When Gold broke above trendline resistance, the Volume Rate of Change indicator surged higher, showing that buyers were extremely interested in buying Gold.
Using volume to confirm price analysis can help a trader make better trading decisions. The section discussing how to interpret Volume would be an excellent addition to this Volume Rate of Change section (see: Volume).

Volume Oscillator

The Volume Oscillator consists of two moving averages of volume, one fast and one slow. The fast volume moving average is then subtracted from the slow moving average. The Volume Oscillator is interpreted using the same principles as volume analysis:

1. An increase or decrease in price accompanied by an increase in volume is considered a sign of strength in the prevailing trend. Therefore, when the fast volume moving average (default 14-period) is above the slow volume moving average (default 28-period), the Volume Oscillator is above the zero line and is confirming price direction, whether it be up or down.
2. An increase or decrease in price accompanied by a decrease in volume is considered a sign of weakness in the prevailing trend. Therefore, when the fast volume moving average is below the slow volume moving average, the Volume Oscillator is below the zero line and is warning that the price direction is lacking strength and conviction.

An example of the Volume Oscillator is presented next in the chart of the E-mini Russell 2000 Futures contract:

The fact that price is making higher highs and higher lows is a bullish sign. When the price increases in the Russell 2000 e-mini is combined with the Volume Oscillator making higher highs and higher lows, a double bullish sign is given.
The Volume Oscillator can be used as a confirmation indicator, as it was above with the Russell 2000 e-mini future, or it can be used to detect divergences.

Volume Oscillator Divergences

Volume Oscillator divergences occur when there is an increase or decrease in price which is accompanied by a decrease in volume. When this divergence occurs, the fast volume moving average (default 14-period) is below the slow volume moving average (default 28-period) and the Volume Oscillator is below the zero line. These divergences are warnings that the current price direction is lacking strength and there is potential for a trend reverse.
An example of a Volume Oscillator divergence is presented below in the chart of the E-mini Russell 2000 Futures contract:

When the price was increasing in the Russell 2000 e-mini, the Volume Oscillator was not confirming the price movement because it was decreasing making repeated lower highs and lower lows. This bearish divergence indicated that the recent price increases were not being made with volume strength. The bearish divergence was confirmed when the e-mini future's upward trendline support was broken. However, when the Russell 2000 e-mini futures contract made its downturn, the Volume Oscillator confirmed the price downtrend by making higher highs and lower lows, a signal that volume was increasing and thus indicating that the trend downward had strength. The Volume Oscillator is a helpful addition to any technical trader's toolbox. Analyzing volume gives traders another viewpoint for analyzing potential trades. 

 

Volume Accumulation

The Volume Accumulation indicator combines volume and a price-weighting that shows the strength of conviction behind a trend; the Volume Accumulation indicator is a helpful tool in uncovering divergences. The formula for the Volume Accumulation formula is shown below:

• Volume x [Close - (High + Low)/2]

The formula only gives positive volume to the day if the close is higher than the midpoint of the high and low. If the close is towards the lower half of the range of the price action, then volume is negative for the day. A chart compares the Volume Accumulation indicator with the On Balance Volume indicator that adds positive volume if the close is higher than the previous close, even if the close is only a penny higher, is given next of the stock:

As can be seen in the chart above, Volume Accumulation was giving a more realistic representation of what the stock of Citigroup was doing - going downward. The logic behind the Volume Accumulation technical analysis indicator is follows:

• An up day on high volume is considered bullish, because volume is being transacted at higher prices; for example, there is an imbalance of supply and demand, demand is more than supply, therefore price increases. The fact that there is much volume shows that the size of the supply and demand imbalance is large.
• A down day on high volume is considered bearish, because volume is being transacted at lower prices. With an imbalance of supply and demand, there being more supply than demand, then prices will go down. Since their is high volume, this is a bearish signal because there were many more stock traders and investors trying to get out of their position and willing to do that by asking a lesser price.

An important use of the Volume Accumulation indicator is to confirm price movements and show divergences between the indicator and prices, signaling a potential reversal in trend.

Volume Accumulation Divergences

Any increase or decrease in price with little volume is to be looked upon with skepticism. The Volume Accumulation indicator helps show instances where price is making new highs or lows, but the indicator is failing to confirm those price moves. Also, the Volume Accumulation technical indicator can confirm price movements.
The chart below of the contract shows examples of these divergences, both bearish and bullish:

High #1 to High #2

The E-mini Russell 2000 future made a lower high; this move lower was confirmed by the Volume Accumulation indicator which made a lower high as well.

Low #1 to Low #2

The emini futures contract made a lower low; however, the Volume Accumulation indicator did not confirm this move. Instead, the indicator made a higher low, a bullish divergence suggesting that the bottom had arrived in the price of the futures contract. This bullish divergence was a strong indication for traders to lessen the size of their short positions or even buy to cover all their short positions.

Low #3 to Low #4

The Volume Accumulation indicator confirmed the price increase in the e-mini future by making a higher low. During periods of confirmation like this, traders feel much stronger about stock or futures positions that are held in the direction of the major market trend.

The Volume Accumulation is a very useful technical analysis tool that combines both price and volume. Other similar technical indicators include Chaikin Oscillator (see: Chaikin Oscillator) and Money Flow Index (see: Money Flow Index).