Pros and Cons of Volume

Discussion in 'Trading' started by jorgemb, Jun 12, 2003.

  1. jorgemb

    jorgemb

    I have read several scattered posts on the use of volume as an indicator of price movement. Some pro and some con. I would like to see some discussion on this issue. As for me, I only trade from the long side and I believe it can be a very useful mechanism for confirming a trend. Specifically, when prices go up accompanied by rises in volume I conclude that it would be a good time to buy or hold. Conversely, rising prices with decreasing volume lead me to conclude that it's time to sell. I am very green at this, however, and I would love get some of the great feedback I have seen at this site.

    Thank You

    Jorge
     
  2. Use of volume to confirm price is recited by many gurus. I have never seen any testing that confirmed it worked however and in my experience volume simply follows volatility.

    Let's say a stock makes a new high. It could have low volume, average volume or high volume. The conventional wisdom is the high volume new high is the best one to buy. But why? It seems tome the low volume breakout has shown impressive ease of movement, ie there are no sellers. Which would you rather own, a stock that used up a lot of buying power to break through heavy selling or one that made a new high on cruise control? I know Bill O'Neill, the publisher of Investors Daily, would say go with the volume, and I am reluctant to oppose him, but this is one concept I've never understood.
     
  3. dbphoenix

    dbphoenix

    Volume's a bit trickier than you might think. The conventional "wisdom" is that you want strong volume on breakouts, and when one doesn't get the two together, he thinks that the breakout is faulty. There is also a general perception that one wants to see strong volume accompanying a rise (or fall). But neither is the case.

    Remember first of all that volume reflects the number of shares traded. If a lot of shares are being traded, there will be a lot of volume. Whether all of this is good or bad depends on what is happening with price. If price moves up decisively on strong volume, then there is not only enough demand to absorb those shares but to drive the price higher as well. If price moves up only marginally on strong volume, then the demand is just enough to absorb the shares, but not enough to drive the price higher. This is called "distribution", i.e., shares being sold under the cover of apparent demand in order to avoid driving the price lower.

    But getting back to your original question, it is not necessary to see strong volume on a breakout. Sometimes it is necessary to attract attention in order to attract the buyers. The volume, therefore, may not come in until the next bar, or even the bar after. If the volume never does, though, the breakout will fail because nobody cares.

    Strong volume, however, need not continue. Think of the accelerator on a car. If you give the car quite a bit of gas to get it moving, you can ease off the accelerator and coast, only occasionally pressing it a bit in order to maintain velocity. On a chart, this results in what is called an LLUR pattern, lower left to upper right, slow, steady, sticking to a trendline like glue, often with seemingly no volume at all.

    On the other hand, if you don't give the car much gas, it will ease off to a stop as soon as you take your foot off the pedal. Volume is necessary, but not a constant press of it. In fact, continuing strong volume can kill a rally since ever-increasing waves of supply are being dumped onto the market. At some point, demand will simply dry up, so you want to see that supply easing off at some point. Otherwise, you may end up holding the bag.

    As for retracements, these are something you should look forward to, not dread. These give traders who missed the breakout the opportunity to get in. If volume falls off during the retracement, then picks up again on the upswing, then new buying is in evidence and you're in good shape. However, if volume picks up on the retracement, make sure you are at least at breakeven, since the retracement may well turn into a reversal.
     
  4. Volume is like everything else in trading; you've got two faces. On one hand, is volume confirming the move or is it the signal for a reversal? The bar grows proportionately and at the same as volume grows, so it's kinda hard using it as an indicator.

    Myself, 3 things get my attention: extreme increase in volume/extreme decrease/volume spikes. Within time period of study. Otherwise I don't pay much attention to it.
     
  5. jorgemb

    jorgemb

    Thank you. Glad to hear all the different thoughts on volume. I really appreciate the quality of the material.

    Jorge