Option Investor
Trader's Corner

Should Volume Confirm?

Printer friendly version

We all know the trader's maxim that volume should confirm a move. Traders listening to CNBC have at times heard an exuberant commentator note that an upside breakout occurred on strong volume, with that commentator explaining that the volume confirmed the upward momentum. Traders have heard a worried technical analyst comment that a decline occurred on strong volume, hinting that such an occurrence guaranteed more declines.

Is either of those suppositions true? Maybe not. Probably not, if price closed well off the high on a strong-volume upside breakout or well off the low on a strong-volume breakdown.

Annotated Daily Chart of BAX

Note that articles are sometimes prepared in advance or sometimes look back to periods that illustrate a particular point, and so do not always reflect current price. According to conventional wisdom, the strong volume confirmed the bearishness of BAX's price action, but did it?

Some who look at the markets differently wouldn't think so. A different interpretation could be that institutional investors stepped in and bought the dip, creating that extraordinary volume spike and being responsible for the close off the day's low. Sellers were met by willing institutional buyers, and the buyers prevailed by the day's end. The subsequent bounce was an intermediate one, although certainly tradable, as was the retest of the zone in December, but that $36.50-36.75 zone was finally violated early this year.

If selling on strong volume isn't necessarily a confirmation of the bearishness of a stock's behavior, is a bounce on strong volume any better confirmation of its bullishness? Again, not necessarily.

Annotated Daily Chart of BCR

This chart was prepared at the open Friday, April 21. With the evidence of the first two gaps higher on strong volume, should the one that occurred two days prior be trusted? The combination of the huge volume and close well off the high of the day on April 19 suggest that some sideways/sideways-down consolidation may be due, although the close well of the low of the day that day may complicate conclusions somewhat.

Another example could be found on Bellsouth's daily chart.

Annotated Daily Chart of BLS:

This BLS chart was also snapped at the open Friday, April 21. Note that the ideal entry has passed and Bellsouth's prices now fall into possible gap support, so this should not be deemed a suggestion to enter a bearish play now.

Of course, a bounce on strong volume and prices that hold most of the day's gains can mean just what you've always told it means: that volume is corroborating the bounce.

Annotated Daily Chart of BA:

Similarly, a decline on strong volume on a day when prices close near the low of the day indicates that institutions were active that day, but perhaps they're not quite through selling, unlike the BAX example from last fall that begins the article.

However, perhaps the charts contained in this article will convince traders to think differently about breakouts or breakdowns on strong volume. Not all such big-volume moves should be considered confirmation of the move. Sometimes, depending on what happens with the price action, they may be showing that institutions are using the breakout to either distribute or accumulate stock. It pays to be aware of when that might be happening.

Trader's Corner Archives