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:
- 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:
- 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.
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.
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:
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:
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.
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 (firstname.lastname@example.org)