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Volume- A Critical Technical Analysis Indicator

Volume is the number of shares or contracts that trade over a specific period of time, usually one day. On a chart, volume is represented as a histogram (vertical bars) below the price chart. This indicator is an essential part of every technical formation as a price pattern will typically have a volume pattern attached to it. In other words, we use it to confirm trends and chart patterns. If a stock is truly in an uptrend, we would expect the volume to also be in a similar pattern. This will increase the chances of the trend continuing. Any price movement up or down with relatively high volume is seen as stronger and more reliable than a similar move on weak volume. The same guideline holds for changes in the MACD and stochastic oscillators. If we see positive or negative signals in these indicators, they are more significant on high volume and less so on low volume. 

Some chartists will draw a trendline on volume and compare it to the trends of price and other technical indicators. If they are not moving in the same direction, we have a negative volume divergence. For example, if price is rising and volume is declining, there could be a trend reversal on the horizon. On the other hand, if price is declining and volume is accelerating, this negative trend is confirmed and a sell signal is more meaningful. Such an example can be found in the chart below:

Volume verification

  • The red arrows highlight strengthening volume
  • The blue arrows show a declining price trend
  • Volume is also confirming a negative MACD divergence (green circles)
  • Volume is also confirming a negative stochastic oscillator divergence (red circles)

 

In the next chart below, we have an example of a negative volume divergence, demonstrating a potential trend reversal:

Trend reversal- Volume divergence

  • Red arrows highlight volume confirmation of price acceleration
  • Blue lines show weakening volume and price consolidation
  • The green arrow shows a severe price reversal with volume confirmation (green circle) as the volume bars are much higher than during consolidation. 

Technicians who look for specific chart patterns such as triangles, flags and head and shoulders can also utilize volume patterns to confirm the accuracy of these patterns. Another important concept in technical analysis is that volume precedes price. If volume is weakening during an uptrend, it is oftentimes a signal that the trend is about to reverse. 

Conclusion:  

Volume is an essential technical analysis tool that will verify the significance of a price pattern or technical analysis indicator confirmation or divergence. It can also be predictive of upcoming changes in chart patterns. We use volume to corroborate buy/sell signals. A positive or negative signal on high volume is much more significant than one on low volume. Volume surges (1.5 x normal volume) are especially significant.

Market tone:

On a 1 – 10 scale, I’d give this week an “8” for predominantly good news reports. On the negative side, productivity declined in the 2nd quarter by 1.8%, about double initial estimates. Also, total construction was down by a higher-than-expected 1.0% in July. The good news dominated:

  • New orders for manufactured goods rose 0.1% in July after two months of decline.
  • Consumer spending and income rose in July after zero growth in June.
  • Consumer confidence rose 2.5 points in August
  • The private sector lost fewer jobs than anticipated
  • The ISM found that the manufacturing activity in August was better than expected.

For the week, the S&P 500 was up 3.7% (including dividends) for a year-to-date return of 0.4%.

I constructed a 3-month chart of the S&P 500 which shows a mixed technical picture as seen below:

S&P 500 as of 9-3-10

 Note the following:

  • The long term (red arrow) is trading above the short-term (blue arrow) moving average.
  • Price recently broke above the 50-d MA (green circle)
  • MACD recently turns positive (orange oval)
  • Stochastic oscillator turns positive (purple oval)

I also constructed a longer term (1-year) chart of this benchmark as seen below:

S&P 500: 1-year volume

 Note the following:

  • In the last few months the market is trading in a sideways pattern (red box) rendering it more difficult to predict a direction
  • Volume has declined in the last few months (blue arrow) as one would expect in the summer months. This makes the technicals less significant and once again market direction difficult to predict.

 These mixed technicals along with the weak volume are the contributing factors to the neutral and defensive market stance I have been maintaining and continue to do so.

Summary:

IBD: Market in confirmed uptrend.

BCI: Neutral selling predominantly I-T-M strikes.

Wishing a happy and healthy holiday weekend to one and all,

Alan and the entire BCI team (alan@thebluecollarinvestor.com)

 

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About Alan Ellman

Alan Ellman loves options trading so much he has written four top selling books on the topic of selling covered calls, one about put-selling and a sixth book about long-term investing. Alan is a national speaker for The Money Show, The Stock Traders Expo and the American Association of Individual Investors. He also writes financial columns for both US and International publications along with his own award-winning blog.. He is a retired dentist, a personal fitness trainer, successful real estate investor, but he is known mostly for his practical and successful stock option strategies.

27 Responses to “Volume- A Critical Technical Analysis Indicator”

  1. DaveD September 5, 2010 2:44 am #

    Hi Alan,

    Just a few questons…

    1) How can we find a companys annual sales or revenue?

    2) How can we fnd a companys revenue growth?

    3) How can we find a companys bare cash?

    4) Can any of the above be found on IBD?

    5) Do you consider any of the abover things when buying a stock?

    Thanks Alan

    Dave

  2. admin September 5, 2010 8:08 am #

    Dave,

    Some of the information like revenue growth, can be found on the IBD site above the graph on the quote page. More information can be accessed by clicking the “Get IBD Checkup for_____________ in the blue rectangle above this information.

    A better place to get specific fundamental company information is from the MSN site (FREE) where we access the Scouter Rating:

    http://moneycentral.msn.com/investor/StockRating/srsmain.asp

    On the left side of the page click on “Research”

    Put in the ticker and fundamental info will appear.

    Also, on the left, hit “key ratios” and get comparison information of your stock, its industry and the S&P 500.

    For several years of financial statements, look for the link on the left “statements”.

    Premium members who no longer subscribe to the IBD site will find this site particularly useful in this regard.

    I ABSOLUTELY consider fundamental analysis in my decisions (“the best performing stocks in the best performing industries”) as well as technical analysis and common sense parameters (diversification, ERs etc.). Here is a paragraph taken from the new book I am writing:

    “What Fundamentals does the BCI System Utilize?

    It considers plenty, although it doesn’t take us all that long to calculate. First, let’s look at the IBD 100 stocks and the fundamentals evaluated:

    • Return on Equity
    • Earnings per Share rating
    • Annual EPS % change
    • Last Quarter EPS % change
    • Next Quarter EPS % change
    • Last Quarter Sales % change

    In addition, we run the stocks through the SmartSelect (Green Alert) ratings. The “EPS Rating” compares a company’s earnings per share growth on both a current and annual basis with other publicly traded companies. It compares the company’s most recent two quarters of EPS growth with its 3-5 year annual growth rate.

    Furthermore, the Scouter Rating factors in many of the fundamental qualities of equities that have proven statistically to be predictive of stock performance in the past. In other words, we have all bases covered when it comes to fundamental ratios and analysis.”

    Alan

  3. Bill September 5, 2010 1:48 pm #

    I have a question about the unwind now tab. I can’t seem to get the answer out of the “exit strategies” book. I purchased apkt on 8/24 for 31.20,sold sept 32.50 call for 1.00 (roo 3.2 with 4.2 upside). Price is now 36.41, cost to close option 3.90. Using the unwind now tab, return would be 7.63 for 13 days. Pretty good.

    My question is why would I do this? Just to free up the cash? Does this assume you will sell the stock right away?

    What about rolling out or out and up? Is it too early to do that for the Oct contracts?

    Sorry for all the questions but just looking for some other mindsets in situations like this.

    Bill P

  4. admin September 5, 2010 5:09 pm #

    Bill,

    Glad to help. That’s why I developed this site….to assist and share with each other. The “unwind now” tab of the Elite Calculator was developed after I wrote “Exit Strategies…”. A full discussion WILL be included in my third book which I am currently writing.

    I use this strategy when a stock has appreciated to the point where the time value of the option premium has declined close to zero and there is still time left in the contract cycle. If you were to unwind your position @ $4.10 (according to the option chain….check the “ask”, not the “bid”). The time value of the option value is $0.19 ($4.10 – $3.91). The latter figure is the intrinsic value and the amount your shares will be worth above the strike originally sold. So, if you then sold the stock it would cost you $19 per contract + commissions. Now if you were to use this cash to enter a new position and generate more than this amount, you have created a second income stream with the same cash in the same contract cycle. For example, if you sold the $41 call on RVBD, you could generate a 2%, 2-week return for this I-T-M strike.

    It is too early to roll out or out and up. I reserve these strategies for the last week of the cycle to minimize my equity risk. Here is a link to an article I wrote several months ago with more detailed information:

    http://www.thebluecollarinvestor.com/blog/closing-covered-call-positions-mid-contract-the-elite-calculator/

    Alan

  5. admin September 6, 2010 3:37 am #

    Premium members:

    This week’s Weekly Stock Screen and Watch List has been uploaded to your premium site. The ETF Report was uploaded last Friday.

    Alan

  6. owen September 6, 2010 10:51 am #

    Just a reminder of one of the factors in the daily volume: Short Sellers. Well, not so much the sellers who are selling, as the sellers who are buying because they are losing money as the stock goes up.

    I find short interest a useful piece of information. Here’s why. GMCR short interest is 22.84 million shares. The outstanding shares are 131.94 million. The short interest is 17% of the total shares. With an average daily trading volume of 2.56 million shares it would take 8.9 trading days to clear the short interest. And, that’s if NOBODY buys any shares because the stock is going up and they want in on the gain.

    Now, I’m not touting GMCR. I don’t even know if it meets the BCI screen tests. The point it this, 17% of the stock having been borrowed, and needing to be bought back and returned by the short seller, there will be a great deal of extra buying pressure on the upside as the stock rises.

    A couple of comparison examples of short interest percentages as of Friday, Sep 3: BIDU 2.9%, CAT 3.3%, C 1.4%, GOOG 1.7%, AAPL 1.1%. All of these stocks will be rising because people want to own them. The short covering will have little impact as they rise.

    By the way, the short interest on NFLX is 19.9%.

    Happy trading, everyone.

  7. owen September 6, 2010 11:11 am #

    Also, if you want a quick view of short interest, this reminder:

    http://www.dailyfinance.com/

    You can also access it from the middle of the AOL home page by entering a symbol to get a quote. Seems like a few people are betting against Warren Buffet. The short interest on BRK.B (the class B shares) is 38.7%. One of them is going to be wrong.

    Oh, well. Remember, the only person who was right 100% of the time in the stock market was Ivan Boesky. He got 3 1/2 years in jail, and a $100 million fine for it.

  8. Barry B September 6, 2010 2:15 pm #

    Owen…

    I love your insights…thank you. Also, your comment about Ivan Boesky was great.

    BB

  9. owen September 6, 2010 2:51 pm #

    You’re welcome, Barry. I believe most people try to learn something so they can apply it. The last thing I want is for people who have bought Alan’s books and DVDs to put them on the shelf and ignore them. Covered call writing is not riskless, but the risk is controllable to a certain degree. If you refuse to take a loss, you should be trading certificates of deposit.

    I can tell by the questions and discussions that there are many people out there who are blue collar investors. Like Alan, I want to give them any little extra edge I can. Success builds confidence and confidence builds success. Scraping 1% or 3% per month off of the Wall Street gravy train is a very nice return.

    One of the most important math concepts I try to teach people is that there is absolutely no difference between making $100 on a $1,000 investment, and making $100,000 on a $1,000,000 investment. The absolute dollars are not the same, but the investment return is identical. Both investors had the same success.

  10. admin September 6, 2010 7:51 pm #

    To all,

    1- Another place to access short interest info that Owen mentioned (great point!) is”

    http://finance.yahoo.com/

    Type in ticker and “get quote”

    On right side of page, click on “more key statistics”

    2- I’ve had a few offsite comments about stocks on the premium watch list (like SVR) that passed all screens but showed no “o” for having options in the print version of the IBD. This was simply an oversight by IBD that we picked up because the stocks were already in our database of optionable stocks.

    Alan

  11. Barry B September 6, 2010 8:52 pm #

    Since IBD has historically had occassionally incorrect indications as to whether a stock has options, we use other tools to screen for optionable stocks that tend to give more reliable data. After we determine which stocks do not have options, we run those stocks through a broker platform to make sure that the alternative sites we use are correct.

    For some reason, many data services are not as tight with this metric…so we use multiple screens as well as a brokerage platform.

    Barry

  12. Rob September 7, 2010 2:05 pm #

    Alan,

    I’ve been a premium member for two months and noticed that ffiv has been on your list for 23 weeks. I’ve been trading with this stock for well over a year with great success. Wondering why it wasn’t on your list for a longer time frame. Just curious.

    Thanks and keep up the good work.

    Rob

  13. admin September 7, 2010 5:08 pm #

    Rob,

    23 weeks is actually how long the Weekly Stock Screen and Watch List has been available to our members. FFIV was also on the list for the additional year it took to develop and refine the report. I hope many of our subscribers have come along for the “ride”. Congrats on finding this one.

    Alan

  14. Don B September 8, 2010 12:28 am #

    Alan –

    I am puzzled over the removal of SHOO from the Running List 9/3. Looking at the chart technicals shows no weakness to speak of. The Stock Scouter gives it a cheerful 7! Can you elaborate? Thanx much.

    Don B.

  15. Barry B September 8, 2010 12:52 am #

    Don B
    Re: Post # 14

    Don,

    SHOO failed the Smart Select Screen this week. Further, to better manage the running list and keep it a reasonable size, we remove a stock if it failed to pass all screens four weeks in a row. The last time SHOO passed all of the screens was 8/6/10.

    Best,

    Barry

  16. admin September 8, 2010 8:58 am #

    ALTR- positve earnings guidance:

    Altera Corp. (ALTR) said it expects third quarter revenue of $516.2 million to $535.0 million. The company’s previous guidance was revenue of $488.1 million to $506.8 million and the current consensus estimate is revenue of $498.2 million for the quarter ending September 30, 2010.

    This stock is highlighted in our current premium report as having passed all BCI screens.

    Alan

  17. admin September 8, 2010 2:07 pm #

    VRX:

    Strong fundamentals and technicals but not part of the IBD 100 (yet). I’ll have my team add it to the premium watch list at the next publication this weekend.

    Alan

  18. Don B September 8, 2010 2:25 pm #

    Hi Barry –

    Your response in #15 is indeed appreciated. Yet, I still do not know what weakness SHOO displayed to cause it to fail. I.E., what tech or fundamental problem reared its ugly head! Trying to determine if I should just take my punishment or if I should hold for better days. Thanx much.

    Don B

  19. owen September 8, 2010 5:55 pm #

    The highest the stock has ever been is $40, and it hit that twice in the last couple of months. I think it’s a ceiling the market is setting at this time, justified, or unjustified. Unless you really love Steve Madden shoes the only thing that matters is what the market thinks of the stock. It doesn’t like $41 (for now). Short interest, by the way, is 7.5% of the outstanding shares, which is pretty modest.

    That’s my two cents worth on SHOO.

  20. BarryB September 8, 2010 8:02 pm #

    Don B,

    This week SHOO failed the Smart Select Screen…the institutional accumulation/distribution metric…the stock is most likely being sold by the institutions.

    Barry

  21. Amy September 9, 2010 10:19 am #

    Alan,

    On last weeks blog comments (August 30 and 31st) you mentioned GMCR and since then the stock price has increased from $30 to $35. Can you review what caught your eye about this stock since it wasn’t on the premium watch list.

    Thanks for your help.

    Amy

  22. admin September 9, 2010 11:17 am #

    Amy,

    GMCR was a stock that made significant profit for many of us last year until the April downturn. It’s hard to forget “old friends”. Here is what made me mention this equity:

    1- It has been uptrending the last two months

    2- Great fundamentals

    3- Improving technicals

    4- *****Price increases with increasing volume. This fits right in with the theme of this week’s blog article. It showed the probability of continued institutional support during a time when market volume is traditionally low.

    To sum up: No unique superpowers, just sound fundamental and technical analysis with common sense thrown in. Our goal should not be to be correct 100% of the time, that’s impossible. However, more often than not is achievable.

    Alan

  23. admin September 10, 2010 8:54 am #

    THE ETF REPORT HAS BEEN EXPANDED:

    Premium members: The BCI team has enhanced the ETF report by now indentifying and charting the top 3 performing S&P 500 Sector ETFs. This is IN ADDITION to the traditional list of top-performing ETFs in ALL asset classes. As a result, you will have more choices for your ETF portfolio and an increased selection of domestic securities. The BCI team continues to make very effort to elevate the quality of the educational products we provide to our subscribers.

    To locate this report, look in the “resources/downloads” section of the premium site for “Top performing ETFs dated 9-10-10.

    Alan

  24. Don B September 10, 2010 1:19 pm #

    This morning I wrote 3 Oct 32 Calls on FST. I observed before doing so that the Volume was zero, while the Open Interest was 38. Just as soon as I got filled, I note naturally enough that the Volume was now 3 – and yet the Open Interest remained at 38. Simply put, what gives here? TIA.

    Don B

  25. owen September 10, 2010 2:53 pm #

    Don – I’m willing to go out on a limb and suggest they may not update the figure until the end of the day, when they see how many are still open. 3 and 38 are showing up on Investools, Schwab and AOL Daily Finance. it will probably goe to 41 tonight.

  26. admin September 10, 2010 5:18 pm #

    Don and Owen,

    One other possibility is related to the fact that open interest is a cumulative and ongoing figure. In other words, just as Don opened 3 positions today, three others may have been closed. Volume is re-set at the beginning of each trading day. If we added 3 OI positions, the published OI may not go up in sync withn that figure.

    Here is a link to an article I wrote last year on this subject:

    http://www.thebluecollarinvestor.com/blog/stock-option-chains-open-interest-and-volume/

    Alan

  27. owen September 11, 2010 2:12 pm #

    Even the CBOE has 38 open contracts on Saturday, so it looks like Alan was correct. The three contracts to sold to open were being bought by someone buying to close. Net change = zero.

    By the way, the reference to CBOE, for those of you who do not know the initials, is the Chicago Board Options Exchange. It is the pretty much the origin of options trading, and many of the options contracts that are traded. If you want to see more information you can go to http://www.cboe.com

    Just another useful resource to add to you list.

    Note: Alan alerted me to an error in the description line on page “Code D5” in the options calculator. It should read “I SOLD …” rather than “I BOUGHT …”. I did not do a page for buying to open, because that isn’t what the BCI is about. It’s very risky and should only be used by the most experienced traders.

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