Interpretation of Price and Volume

Interpretation of Price and Volume Together

If we limit our observations to price alone, we are likely to miss some important emerging signals. We also need to keep an eye on trading volume. When buying or selling volume levels change significantly,

Figure 1-9

it could signal a coming change in the price trend as well.

Figure 1-9 is a 30-minute bar chart of Microsoft (MSFT). Price trendline A is up but the volume trendline A is down. As prices have moved higher, volume has waned, indicting that fewer and fewer buyers are coming into the market. It appears that the upward drive is exhausting itself. The price reacts by retreating back down to form a low at $55. Here, the volume expanded noticeably, exhibiting a bottom-heavy activity coupled with a downside price trend. Bargain hunters step up to absorb the stock at its softer price level. At point C, the market opens lower and rallies with volume at its highest level to this point. But as prices begin to climb at trend line D, volume recedes. The market rolls over as prices fall; volume expands (Point E) but prices continue to slip lower. Demand is not strong enough to support that price level. Volume continues to rise (trend line F) as price falls, until the price gaps down to $53, and volume reaches its highest point on the chart.

When prices climb and volume falls, buying activity is weakening. As prices fall and volume declines, selling activity is exhausted. As prices fall and volume rises, and as prices then hold in the same area with rising volume, that means buying activity is growing in strength; if prices rise to a point that they stall and volume continues to rise, it indicates that sellers are gaining momentum.

Daily movements of price, as a chaotic and momentary force, may appear to be setting net SR trends but, in fact, are merely part of a larger and longer-term pattern. Of equal importance, remember that identifiable trading ranges are not always present. Highly volatile stocks often have not yet found a trading range, so prices rise or fall in reaction (often overreaction) to many market forces. In those cases of extreme volatility, few charting techniques are of any value. Highly volatile stocks, by definition, do not possess a single trading range and have to be viewed in a larger perspective. A stock's high volatility, in and of itself, makes SR and other charting inapplicable.

Summary

Support and resistance, the study of the interaction between buyers and sellers in relatively low-volatility stocks, is the foundation of technical analysis. As traders, the study of SR gives us a window into how most traders react to price movement. Most traders do not try to forecast short-term price movements, they follow trends as they emerge.

The professional or active trader's ability to react swiftly to a new trend helps him to understand the interaction between volume and price. The observant technician understands that SR serves as a starting point for developing an idea of what may occur next in price movements or patterns. However, he also knows that short-term price movement has a random quality to it, and spikes or waves may mislead the impatient trader, causing mistakes and misjudgments. A patient trader awaits confirmation from a suspected change in the current trend, remembering that important change is not going to take place every day. By utilizing other indicators, the technician is able to use SR and emerging chart patterns to anticipate the next step in price trends. The next chapter explains how SR applies to one of the most important theories of the market, the Dow Theory.