My two topics are both related in the sense that they are about patterns that both suggest trend reversals. I'll say a little more on daily trading volume than just relating to 'climatic' volume surges.
I got a couple of e-mails over the weekend with one relating to a possible island top in the Nasdaq Composite (COMP). I thought I'd answer now on this formation while the pattern is still present. Then, we can see how 'long' its good for or how long weakness might persist in COMP.
The other e-mail related to whether spikes in stock volume will always be present in a trend reversal. Answer: not always, but a lot.
As both the island reversal top and the island reversal bottom do suggest trend reversals, the two subjects are related. However, the island type reversal often suggests only a short-term reversal, whereas a so-called volume climax often is more indicative of an intermediate to long-term change in price direction.
The first question I got related to the Nasdaq Composite and what was MY opinion as to an 'island top' reversal pattern that formed in COMP. This wasn't a chart aspect I mentioned in my most recent (11/28) weekly Index Wrap commentary but it is part of the bearish pattern in Nasdaq of late.
The appearance of an island TOP is where a stock or index 'gaps' up to the formation, then gaps down at the same price level, leaving an island type pattern as you'll see on my first chart. This pattern signals at most, again usually, a short-term (up to 3 months) bearish reversal. I'd note that the time frame for follow through weakness can be as short as 1-3 weeks, especially when seen in the indexes. The likely decline is usually only a few percentage points, but can range up to 10%.
The daily COMP chart below has the island top formation highlighted. This pattern has so far 'predicted' the weakness that has followed. What this particular pattern doesn't carry is a 'measuring' implication, unlike some other patterns. Based on an island reversal pattern alone, there's no related prediction how much further the correction will carry. In the case of this recent top, whether the peak to trough correction will be 2-3 percent (such was seen with the last pullback), or deeper than that, such as 5-7 percent or more, isn't suggested. An island reversal is usually significant in trading terms, not always in investment terms.
Predictably enough the island top occurred after a lengthily multimonth advance as seen above. The island top reversal pattern can be seen in close up so to speak by looking at the hourly chart for the same (Nas Composite) Index.
The 'island bottom' pattern is just the reverse of the top and there will be a couple of stock charts related to volume climaxes that 'signal' bottoms where an island bottom ALSO formed.
VOLUME SPIKES or potential VOLUME 'CLIMAXES':
Since we don't have daily volume figures on the indexes, a volume climax is usually guessed at by a huge daily or weekly surge in either or both the NYSE or NASDAQ. An index exception is the Nasdaq 100 tracking stock, QQQQ.
Stocks are a different story and flipping through some of my Dow stock or Nasdaq bellwethers, provided many examples of sizable daily volume spikes suggesting a buying or selling climax, followed by an subsequent major trend reversal. Sometimes a sizable jump in volume is suggestive of a continuation type pattern or one 'verifying' trend direction.
Volume, it should always be noted, is a secondary indicator to price. Price is the dominant measure of trend in a stock or index. Volume will typically (or, 'should') confirm the direction of the price trend by larger volume activity on upswings in a bull market and larger volume surges in downswings in a bear trend. Traders need to respect the trend and not go against the trend just because of a volume divergence. That is until price action shows that the time is right to act.
Charles Dow considered the confirming volume rule to apply to the primary or major trends only and also indicated that volume does not have to always 'confirm' price activity. Still, there are just a lot of instances where volume is a useful indicator and trades can be based on the help provided by this input.
A series of stock charts follow with various notations about spikes in daily trading volume that were significant for the subsequent price trend. Such examples are plentiful in stocks and demonstrate that these volume events provide a great advantage in accessing where a trend has or is reversing. We don't have this advantage so much in the indexes although you can look at the QQQQ daily chart and see the volume surges along the way in its strong advance of recent months.
There is another volume study that is important to study of the trend â€“ sometimes this Indicator will best highlight a divergence in volume versus price. On Balance Volume (OBV) is another way of measuring what is happening with volume that might suggest something in regards to the price trend.
If the direction of the OBV line is UP, the OBV line provides a type of bullish volume indication, as there is more volume on up days than on days when the stock price is down. A falling on-balance volume line is bearish, as more stock is being traded on down days than on up days. If both price and OBV are moving up together, it is a bullish sign suggesting higher prices ahead. If both price and OBV are moving down together, this is a bearish indication for still lower prices.
However, if prices move lower during a period of time when the OBV line starts trending HIGHER, as is seen below, this is a bullish price/volume divergence, suggesting that the stock is being accumulated on the decline. An upside reversal is forewarned by this divergence highlighted below on the TRV chart.
As I noted previously, one clue to the ups and downs of the index trend is provided by the Nasdaq 100 tracking stock, QQQQ, since it provides a daily volume figure. We don't always see QQQQ volume surging on the upside, but there has been a marked tendency for sizable volume spikes on the declines that suggest a 'final' round of liquidation before the stock is ready to resume its advance. Fear and panic mark most bottoms, even ones along the way as in QQQQ.
GOOD TRADING SUCCESS!