A Quick Look at the Importance of Volume

One of the potential scenarios I’ve mentioned recently is more or less a blow-off type of top, we didn’t get that-at least not yet. As I look at the charts I’m seeing another more viable and likely scenario developing. I think it is reasonable to expect to see more of a top develop, perhaps through the summer. The Dow holding close to the 13250 level is what I’ve been looking for since late last week. I hoped that we would see more of a gradual tapering of the decline, like a doji or something similar. I’d feel much more comfortable with a rally scenario under those circumstances, but we have the card face up and we got a mini up-thrusting day Monday. The Nasdaq Composite fits well within this scenario as it held up around 2550. The Naz100 has more room on the downside, 1925 would dovetail into this scenario. The S&P is the odd-man out here as it would have needed to hold around 1485, but 1450 works too, especially considering the presumable support from the Feb highs. None of the major indices is a candidate for a typical head and shoulders top at this point, but head and shoulders are rarely textbook as far as symmetry goes. So we’d actually be looking at something more along the lines of a complex head and shoulders top. There could be anywhere from 1 to 3 or 4 more right shoulders, I’d consider the recent plunge to be the right side of the head.

Last weeks decline averaged around 5.5% making it the worst decline we’ve seen in 4 years. The technical damage incurred throughout the market and most notably within the Financial sector, renders the verdict on this bull, it’s dead. Sure we’ll have some rallies, maybe even a brief new high, but in my opinion, the uptrend is done, we are still within a lateral primary trend and I’d expect to see no better than that for some time. Should this play out as I suspect, then trading opportunities favor buying weakness and selling strength. Now is the time to brush up on your volume analysis. All the other indicators are great, but price and volume are going to give us the best clue as to where and when this beast is going to turn. I figure now is a good time to briefly go over the basics, these are going to be generalizations, but they should help out in your analysis. Maybe sometime this week I’ll get a video out to you.

For the most part, we want to see volume spike significantly above average for breakouts and reversals to the upside. Increasing volume can be tricky on an upside move, we want to see it, but you must always be on the look out for churning or distribution. As a rule of thumb, a healthy price advance should accompany large volume. When you start seeing gaps up and little price appreciation on large volume, then you have to be cautious as this often marks distribution. As price pulls back from an advance, we look for diminishing volume on the move down. An increase in volume around support is okay so long as the price action is relatively light to the downside or as long as it moves up off the support area. A price advance on diminishing volume is always suspect and should be taken seriously.

It is often said that price needs volume to advance, but it can fall of it’s own weight, meaning price does not need significant volume to decline. Many people have an erroneous view of volume on a decline in that they believe that big volume (significantly above average) is bad. In fact a large volume surge after several days of decline, is often capitulation on the part of the sellers, meaning it often signifies sellers more or less throwing in the towel. This is especially true should the breadth of the daily decline diminish each successive day and more so on a day in which the open and close are very close together, such as a doji or a star candle formation or on an inside day. It can be a bit confusing because we look for diminishing volume on a pullback or consolidation, but a large volume spike is desirable on a decline, the difference is simply determining whether you are in the midst of a decline or a pullback.



Candlestick charting is especially helpful in this analysis. While volume spikes tend to catch our attention and play significantly into our analysis, slight increases in volume above average daily volume are also extremely important and are often our first clue that something is up. For instance, pull up a chart of the S&P500 and take a look at the last several weeks. Note how the price advance on Friday the 13th started to see diminishing volume as well as a smaller daily price range, this was a clue that the move up was losing momentum. In and of itself, that doesn’t tell us much except that it may be time to start locking in profits. Now take a look at the doji of July 17th, see how volume started to increase. This was a clear signal that sellers had entered the market above and beyond the simple profit taking that is normally associated with a typical pullback after a price advance. July 18th continued to see the sellers stepping up their efforts as volume expanded again on the decline. The price advance of July 19th left a wick on the candlestick demonstrating on the chart that higher prices were tested and rejected, volume contracted from the previous day. July 20th was a very clear signal that trouble was ahead as volume swelled again on a downside move, in fact we saw more volume on the 20th than we did on the price advance of July 12th. To make matters worse for the bulls, the candle formation of the 20th is known as a bearish engulfing pattern. This is a reversal formation that happens when a down day engulfs the previous day’s “real body” (open to close). While the price action of the 20th did not break presumptive support from the mid June highs, it was enough to send a clear signal that it is time to take appropriate action. The price action of the 23rd left another long candlewick, again higher prices were rejected and note how volume declined as the bulls took the wheel. July 24th was a perfectly bearish day, a big nasty dark candle down and an increase in volume, but not so much that it would be considered capitulation. July 26th was our first hint that we might be coming to the end of this move, or at least catch a breather. Note how much volume expanded and also note how price, while not forming a bullish reversal hammer, did test lower prices and reject them with an afternoon rally. We got one more day of big volume and as I said, I would have preferred price to slow down a bit on the downside before it attempted a move up, but we have what we have. Monday formed an up thrusting formation, perfectly respectable and it did so on significantly above average volume, however nowhere near the downside decline’s. At this point, the S&P may very well run into significant resistance around 1485, we’ll want to see a break of that level occur on significant volume, then it can take a little breather. This is the time to watch for subtly, such as July 16/17th.

I’ll try to cover the sectors I’m watching later in the week, I think there will be a ton of nice short setups and believe it or not, there are a lot of nice looking longs, the Diagnostic Substances group has performed spectacularly recently as have several other sectors. I’ll be putting together the next subscriber list, we had a lot of nice moves today in ideas mentioned here or on the subscribers list, such as PRW on the Tag the other day at $.40 for a 10% advance today or PRZ on the subs list, up nearly 13% today, BDCO also on the subs list, up another 12.5%today. There have been a ton of great picks on our Tagboard as well recently, check it out. Here’s the link for info on the Subscriber list. I’ll be adding ideas to the blog on videos sometime this week as well. Should you care to help support Trade Guild, check out the Subscriber list or a little change in the Tip jar above the Tagboard is always appreciated. Also we are an affiliate of TeleChart/Worden/Blocks so I appreciate you using our links to check them out or try their 30-day free trial of TeleChart and let them know you heard about them from Trade Guild. Also any links you can post on message boards to our site are always most appreciated.