Discover advanced volume analysis in Part-2 of our step-by step guide. Understand importance of volume in relation to price movements. How to implement volume analysis in stock trading and investing after identifying price exhaustion, breakouts and reversals like a professional trader.
Table of Contents:
1. Understanding volume
2. Why volume is important?
3. Volume and chart patterns
4. How volume relates to price exhaustion
5. How volume can identify breakouts and reversals.
6. Conclusion
In stock market,
volume is a fundamental aspect of technical analysis that provides valuable
insights into market dynamics, liquidity and investors' sentiments.
Volume basically measures the number of shares traded in a stock or
number of contracts interchanged hands in futures and options. Technical
analysis is basically a study of price and volume or the study of mass
psychology. More the mass, more the psychology will apply in the market. As per
the amount of mass participation we can identify liquid and illiquid stocks.
Liquid stocks means more mass participation, less participation of mass
indicates illiquid stocks. Most liquid stocks are considered as the best for
short-term trading where more buyers and sellers are ready to trade in
different prices.
Why volume is important?
Volume confirms the
market movements. A market or a stock rises with high volume confirms the
bullishness. High volume means more buyers are ready to push the price higher
and attract more buyers come into the market.
Pro-tip: If price moves higher with high volume
the trend is likely to sustain.
If the price rises
with decreasing volume, it may indicate a lack of interest, and there is a
caution of potential price reversal. Simply, a price rise or a fall with less
volume gives a weak signal. A price rise or a fall with high volume gives a
stronger signal that suggests that some fundamentals have changed in the
stock.
Change in price-volume
relationship indicates weakness in prevailing uptrend.
What does it mean? It
means that when a stock goes up with high volume the trend is likely to
sustain. But when the stock goes more upward with low volume then the
relationship between price and volume breaks. Suppose, a stock goes up with high
volume then this is a strong signal or we can say that the stock is in a strong
trend. If it goes further up but with low volume that means the stock is
nearing to a reversal. Or we can think of a probable appearance of 
in big numbers in the 2nd uptrend.
We know that there are
a lot of chart patterns. Basically we divide them into two types:
1.Eastern chart
patterns
2.Western chart
patterns
In eastern pattern
there are so many charts like doji chart pattern, hammer pattern shooting star
pattern, engulfing chart pattern etc.
In Western pattern
there are patterns like double top and double bottom, triple top and triple
bottom, rectangle pattern, triangle pattern, cup and handle pattern
etc.
When we look at
patterns combined with volume the patterns become significant. Every chart
pattern has breakout or breakdown. Any breakout or breakdown in any stock or in
any instrument, in any timeframe, in any market if it is supported by volume
the breakout or breakdown likely to sustain or give you the target which is
supposed to be. Patterns supported by volume give you higher perspective.
How volume relates to
price exhaustion in the market?
How can you know when
traders are getting tired or exhausted of buying a certain stock? How can you
tell that the upward trend is likely to change? Volume can be a very useful
indicator in answering these questions. When you are doing volume analysis, you
should keep in your mind the following patterns.
If there is a sharp
move in price, either up or down, combined with a sharp rise in volume, then
this may indicate the potential end of a trend. Suppose, you saw a long-term
upward move, but then there was a sudden dip. The next day, you saw a much
larger dip with high trading volume. This indicates that the stock's upward
swing nearing to an end. In other words, we can interpret it as its upward move
has been exhausted. Now it may go down as the market's demand has been
saturated,
Sometimes, we see
there are stragglers in the market who have been waiting to take action, now
they are in FOMO that if they don't take entry now, they will never have chance
to make money on this trade. These people end up swapping stocks with
intelligent, long-term investors who are exiting out seeing the sign of
exhaustion in volume. These stragglers are generally the last buyers at the top
peak of the stock. And if there is a large decline with a heavy volume then
it's a sign that the stock may fall over the longer period of time.
How
volume can identify breakouts and reversals?
How can you tell
weather a stock is ready to breakout or not after looking at volume?
Well, volume analysis
can help you to figuring that out. First, you need to notice a range in which
the stock is trading. If there is a spike in volume after that particular
range, and the stock had previously been rising, then that could be an
indication that the stock will rally further. On the other hand, if there is a
little change in volume or declining volume after the range, that
indicates lack of interest on the part of the broader market. Therefore, this
could be a false breakout. It looks like it will breakout, but then it
won't.
Volume analysis can
help you to determine if a stock or other instrument is moving in a bullish
direction. Suppose, a stock's price is going down, then goes up, and then going
down again. A pattern to look for would be a higher price the second time the
stock went down, as compared to the first. This pattern combined with lower
than usual volume on the second decline is actually an indication that the
stock is ready to rise. That means there is a bullishness in this particular
stock.
Sometimes, you can
look at volume to determine if a stock is about to undergo a reversal. To be
confirmed, a reversal is when a stock has been going up for a long time, now it
is going to decline. Or vice versa. Imagine a stock has been falling for a long
time. Perhaps six months. If you notice that the price is stabilizing, with
little movement and high volume, then this can indicate a reversal in the
direction of the stock. That huge volume is an indication that people deciding
the stock is cheap enough to buy and that can set a new floor for the stock. It
also signifies that there are more buyers than sellers who are holding the the
stock with a hope that it will rise again.
Conclusion: Volume analysis is a
type of analysis that you conduct by looking at stock charts. Volume bars are
found at the bottom of the charts. If you conduct volume analysis correctly, it
can help you to identify market trends, breakouts, reversals, exhaustion and
give you higher perspective to take better trading decisions.
Disclaimer: The information provided on MoneyWiseMind is for educational and informational purposes only. It is not intended to be financial advice, and you should not rely on it as such. Before making any financial decisions, you should consult a licensed financial advisor.
