Prices head higher on strong volume. That's confirmation of the climb, right? No, that's not necessarily so. I've covered this topic in the past, but it deserves a second look.
In a pricey little book called MASTER THE MARKETS, Tom Williams titles a section "Effort versus Results." Williams cautions traders to figure out the results of that big effort to move prices higher. Was the effort, signified by the big volume, truly a confirmation of the bullishness or did the effort produce signs of significant selling? He discusses the types of price bars, the results of the push, and what each signifies.
One note: I use candlesticks in the charts for this article, but Williams does not use candlesticks on the charts in his book. He uses bars with the range and the close. He's interested only in the day's range and close, but I believe that candlesticks show this just as well as bars and are more visible to my aging eyes, too. I did want to make sure I presented this point for your consideration, however.
Annotated Daily Chart of Ford, End of 2003:
The big-volume punch higher at the arrow was hit with selling that knocked prices back below the opening level. The results were not positive.
In Williams' book, available on the www.tradeguider.com website, he claims that volume shows activity by smart money, but then traders have to determine the result of that activity. Market makers and specialists, he says, have unique insight because they can see the big orders sitting on either side of the current market levels, but the rest of us have to use the tools we have available. Watching the price range and closing level in conjunction with volume gives us a glimpse of what the market makers and specialists have seen. An effort to rise should be confirmed by a big-range day with prices closing near the high.
That didn't happen with Ford's stock at that big-volume punch higher in late 2003. All that effort was swamped by selling. The result, a candle with a long upper shadow, was not a confirmation of strength but rather a sign of weakness.
Williams might also argue that the volume was so excessive that it indicated supply being unloaded. Traders should be wary when they see this type of volume, he warns, looking for signs of weakness at market tops and signs of strength at market bottoms when such excessive volume comes into play. An effort to rise should be met with high volume, but not excessively high volume. Excessively high volume at new or relative market highs can indicate distribution.
Confirmation that smart money wasn't interested in F's stock above $16.00 came in early 2004 as prices rose into a retest of that late-December high.
Annotated Daily Chart of Ford, Early 2004:
Smart money had unloaded supply previously and wasn't interested in buying F stock at the prices in December 2003 and January 2004. The retest was accomplished on decreasing volume, and the candle was a small-range one.
Another chart shows a different result on a day when prices rose on strong volume. An effort was made to push ADP's prices higher in early August 2006. The result of this effort proved much different than the effort seen on Ford's chart.
Annotated Weekly Chart of ADP:
The effort made by smart money was shown by the increased volume. That volume had increased over the immediately preceding weeks, but was not excessive when compared to ADP's volume pattern. It was, however, strong enough to show that smart money was active that day because only the smart-money people can drive volume that strong. These are those people managing the monies of big funds and institutions, along with some others.
The result of the effort was a positive one, with ADP producing the requisite large-range candle and closing near the week's high. This tells traders that smart money was active in the rise and that smart money was buying. Although ADP has since retreated from its post-breakout high, it went on to climb from its $45.00 breakout level into that post-breakout high of $49.88 in November of last year.
Similar concepts apply when prices are hitting a new or new relative low. Both effort, indicated by higher-than-normal but not excessive volume, and the results of that effort are important to see. Prices that spike to a new intraday low on huge volume but bounce into the middle or the top of the day's range at the close may indicate that smart money was accumulating, not selling. Prices that spike to a new intraday low on larger volume than that seen in the previous few periods, but not on huge volume, and close near that low of the day after producing a big trading range for the day, indicate selling.
No method is foolproof, and this isn't, either. Smart money can occasionally be wrong, too. Even when smart money is right and you correctly ascertain the relationship between their participation and the result of that activity, you could be stopped out of a play. When signs of distribution occur at a new high, for example, momentum can carry prices higher before they collapse and succumb to the weakness that had been predicted.
relating effort to the results will help keep you on the same side as
the smart money, Williams asserts, and that's where you want to be.