VOLUME PRICE CONFIRMATION TOOL AND TREND INDICATOR

VOLUME IS THE BEST PRICE CONFIRMATION TOOL AND TREND INDICATOR         

In Chapter 1, we went over the basic rule structure for volume analysis. But how can we apply that to help confirm market price extremes? This is actually fairly simple, if you know what to look for. That is what this section is designed for. It does not matter what market you are trading, whether it be stocks, futures, or forex. The principles are the same and apply to all three markets. Remember that a good trader has a reason for entering a trade. A great trader waits until the signal triggers and then acts on that signal. Just because a market goes up and is “too high” in value does not mean it is going down, at least not until the signals are present. Market price extremes are generally a reflection of high volatility; and with high volatility comes increased market participation or action, and that action is measured or reflected by high volume.

OVERBOUGHT MARKET CONDITION— A DEAD GIVEAWAY          

           If you drop a boulder off a cliff, it falls at a speed that is much greater than the speed of the boulder being pushed up a hill. That is the analogy of what happens when a bull market or uptrend stretches too far too fast, or is “overbought.” So we look for these types of conditions in which to ride the price direction if we are looking to establish a short position or we want to exit a long position before the boulder falls. Using volume analysis in con-junction with indicators is a powerful tool to help you determine whether a market price trend may continue. Look at Figure 4.1. This chart on Amazon is a dead giveaway that the price appreciation was unsustainable; as we see, the market moved from a bullish trend to a consolidation phase with higher highs.

However the volume levels were declining, giving a direct clue that the price advance was unsustainable. When combined with the low close doji pattern, which we will disclose in Chapter 8, and a shooting star, there was no reason to stay long this market. Notice that as prices started to depreciate, the volume increased, which reflected sellers’ active participation, which attracted more selling.

THE “COMEBACK” KID STOCK       

          In Figure 4.2, we see one of the greatest success stories in 2005 for any company, Apple Computer. It just could do no wrong, except when the price of the stock advanced too far too fast, culminating in an overbought unsustainable price extreme.

The fundamentals were quite rosy, as holiday sales were through the roof on iPods and accessories. You want to talk about a racket; this company has products on top of products that accessorize the accessories, none of which are inexpensive. What a gold mine! Holiday sales were strong, and the market blasted off. In fact, notice the gap up, then notice the gap down, leaving what we technicians call an island top. (This formation is covered in Technical Trading Tactics on page 75.) It also formed the low close doji pattern. It really is the volume that helped confirm the market’s overbought condition. As prices broke out of the sideways pattern, from a high near 75 as it went onward to over 85, see the volume decline showing fewer market participants wanting to join the price advance. As the sell-off materialized, like a boulder falling off a cliff, more participants started selling as volume increased, signaling a strong price reversal.

BLOW-OFF TOPS ON VOLUME SPIKES 

Volume levels help confirm the true strength of a price move if the market demonstrates a price increase. If volume does not confirm the market’s new assigned value, something is wrong and a price reversal is imminent. Volume is also a great indicator of blow-off tops, or what is called an exhaustion rally. Volume spikes or surges can and do indicate price reversals, especially after a price advance on declining volume is preceded by a lack of price follow-through. As we study the chart in Figure 4.3, you see that the huge price advance is accompanied with abnormal or heavier than usual volume. You would anticipate that a breakout to sharply higher levels would occur. The high volatility reflects the increased volume levels; and as the next time frame shows, there is no follow-through to back the price advance. This is a clear sign of a price reversal. The low close doji trigger also seals the deal that this was simply a one-day wonder rally that failed, and a price reversal was to be expected.