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Volume Studies

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I wrote in my Index Trader column this past weekend in my summary section (the 'Bottom Line') that I thought that trade this week would likely be quiet, since many key participants would likely be off or not fully engaged in trading. My weekly Wednesday Trader's Corner article also serves as an adjunct to this (Index Trader) column, which is seen in an online (only) section at the Option Investor.com web site. This column can be seen by clicking here.

I was then thinking last night in the quiet before the fireworks I was waiting to see, that did I think that it would be a low VOLUME week and not much follow through to the upside; or, just that prices would not likely follow surge much higher for awhile, after the strong rebound of the week before? More the later.

I knew from looking at the charts of the major indexes that I didn't want to chase rallies and only buy good-sized pullbacks such as back into the upside 'gaps' that occurred when prices finally rebounded sharply in the week before last; ditto on buying pullbacks only in any individual stocks. There hasn't yet been a huge volume surge to suggest big buying coming in. Maybe selling is drying up some, but it still takes concerted buying to lift em.

Then a SUBSCRIBER E-MAIL found its way into my Inbox with the following query about would I:
"... summarize what factors ar important with volume to alert to shifts in stock and index trends. Are there any studies that you use that relate to trading volume?"

I think about volume more than many, since technical analysis, my way mostly of studying the market and making option trading decisions, works with ONLY two inputs: Price and Volume. There is the study of 'sentiment' or market outlook or we could say investor/trader psychology; how bullish or bearish market participants are. But even here, I largely base my concepts of bullish or bearishness on daily call to put option VOLUME ratios.

Some basics or basic rules on volume, as it relates to the dominant trend, are:

1. Volume should expand in the DIRECTION of the trend. A rising trend will generally see higher volume on up days and lesser volume on down days. A falling trend will tend to see the reverse: jumps in volume on declines, lesser volume on up days.

2. Jumps in, or expansion of, daily volume on new highs or new lows is usually telling us that the (existing) trend will continue. But there is such a thing as a 1-day buying or selling 'CLIMAX' when there is a HUGE final jump in volume, followed by a reversal in trend the next day or in the next 2-3 days.

3. High volume 'clusters': when there is a cluster of high volume days after an index or stock has had a considerable run, especially if prices slow their rise or fall, this may be near the end point of the existing trend: this is when all the volume 'comes out' so to speak. Most who are going to buy have done so and not much buying 'power' is left; conversely, near tradable bottoms, a cluster of heavy volume days may occur and suggest that most of those long who are inclined to sell have done so, paving the way for an 'oversold' rebound.

There are two 'Show Me' indicators in the TradeStation software I use that alert to the jumps in volume relative to a certain moving average of volume; e.g., a 50-day average.

One study is called a 'Volume Breakout', where a dot is placed at the high price of a price bar when that period's (e.g., a day) volume is at least 50% higher than the average volume of the last 50 bars. Another study, that is shows a less frequent chart marking (a dot) is called a 'Big Volume' bar, where that bar or trading period had volume equal to at least twice the average daily volume of the last 50 days.

NASDAQ 100 Tracking Stock (QQQQ), Daily chart
(Volume and 'Volume Breakout' study applied)

In the QQQQ daily chart below, the first noteworthy aspect related to volume and price comparisons is that the advancing trend from mid-March to early-April was NOT accompanied by a rising trend in daily volume during that same period. Volume was relatively 'flat'. There was not the cluster of higher than average 'volume breakout' days seen later on during the first and later parts of the mid-April to early-June decline.

Volume rose steadily into the biggest volume day of early-June. This highest volume day, was a noticeable jump over all the other volume 'bars' and was suggestive of a 'selling climax', especially in that the further price decline for that day and in that immediate period was not huge. Rather, it just looked like the bulls threw in the towel.

General Electric (GE) Daily chart.
(Red Dot = occurrence of a 'Big Volume Bar')

Note the first cluster of the cyan dots (Nov-Dec) that show above average volume days relative to GE's 50-day average of daily volume; i.e., a 'volume breakout' day. This was the peak. High volume 'churning' that was probably caused by some savvy market participants selling into strength. When volume grows after a good-sized advance, but prices are not going up, this is a DIVERGENCE that could be suggesting a trend reversal.

Note again the cluster of high volume days in Jan-early Feb; the reverse of the situation at the prior top: sizable volume 'coming out', but prices not slipping a whole lot further, suggesting bottoming action. As well, the large January 1-day spike in volume suggestive of a possible selling climax.

A bearish price/volume DIVERGENCE in GE's chart above is seen in April-May when prices were going UP and volume was going DOWN. The last part of the decline came on steady volume, suggesting a possible turnaround, at least short-term.

WAL-MART (WMT) Daily Chart:

The sharp downside break in WMT came on a Big Volume day. There was a selling climax at the Sept. bottom after many high volume days. A cluster of high volume days occurred then coming into the May top. Any rallies since then have not occurred with any pronounced volume spikes.

Some minor jumps in volume have come on the recent break in Wal-Mart (above chart). What we are seeing in volume is only a minor encouragement to the bulls. This stock seems likely to slip lower still.

JP MORGAN (JPM) Daily chart:

A cluster of high volume days in Sept-Oct was highly encouraging to get long JP Morgan (JPM) stock and its calls. The early-year slide on some high volume days was worrisome for the bulls, but JPM held prior lows/technical support. The recent top was accompanied by some heavy volume days. Recent chart action and volume are in synch and bullish for a move still higher such as back up to the $45 area.

Please send any technical and Index-related questions for answer in Trader's Corner articles to Click here to email Leigh Stevens Support [at] OptionInvestor.com with 'Leigh Stevens' in the Subject line.

** Good Trading Success! **

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