Technical Analysis

Why You Need To Learn Volume

A few weeks ago I talked to 15 different traders: 5 of them have been trading for less than a year, 5 of them have been trading for 1-2 years, and 5 of them have been trading for over 2 years. I asked each of them if they use volume in their trading, and because they know how important I think volume and price action are, they all responded "yes".

Having established that all 15 of these traders are using volume, I wanted to know exactly how they are using it and whether or not they are using it correctly. I remember as a newer trader I always would say that I was using volume but I really didn’t know how to properly utilize volume. So I spend just a minute or so showing each of these traders a chart and asked them to analyze exactly what the volume on the chart is telling us and where we would want to take a position. The results of the survey showed the following:

You can see that only 3 out of 15 traders, or 20%, actually know how to properly use volume in their trading. It certainly wasn’t a surprise to me that beginner and even intermediate traders don’t know how to use volume, but the fact that even advanced traders didn’t know how to properly analyze volume was mind boggling to me.

A few months ago I authored, produced, and published a video trading course that outlined specific price action methods and most importantly talks about how I use volume to spot trades. Today, in light of the results I have found and the lack of understanding that exists about volume, I would like to share with you part of just one of the lessons that I teach in an effort to at least get you headed down the right road in terms of volume.

So just what is volume? Volume is most simply the measure of transactions taking place in the market. So for any one unit of volume we see a transaction, or a buyer paired with a seller, taking place. So why is it important to analyze the level of volume with respect to price movements?

Well, simply put, it is important because we need to know how many people are placing trades at given areas. Remember, supply and demand are what move price, so if we see a large increase in volume followed by a large price movement, we know that there is a very high amount of demand and a relatively low amount of supply. We can then place our trades accordingly and follow the crowd or momentum as price moves higher.

Recently I was getting ready to place a trade on Apple ( $AAPL ) when I found myself using volume to decide if I should get long or short.
As a newer trader, I would see price approaching an area of resistance, for example, and I never would know if I should get short and assume price would bounce off resistance or if I should get long and assume price is going to break out. Well, in the following example, I used volume to tell me exactly what price was going to do next.

In the following chart you will see elevated volume as well as relatively large upward price movements. Price was quickly approaching prior resistance between the $265.80 and $266 area, and I was getting ready to take a short position as price approached this area. However, I always, and I repeat I always, look at volume before placing any trades, and I saw that for mid-morning volume was as high as it normally is during the open or close. This told me that there are a lot more participants taking part in this price movement than normal for this time of day, so I knew that price was much more likely to break through resistance than to bounce off it.

Rather than fight volume and fight momentum, I looked to take a short position instead. And while price did temporarily pullback when hitting resistance, volume returned into the picture a bit later in the day and caused price to continue upward, as high as about $268.50. This represents a $2+ price movement in just a matter of an hour or so, which is a great amount of price movement for such a high probability, high reward, and low risk scenario.

Let’s zoom in and look at exactly what happened and exactly why I didn’t take a short position. In the chart below, we can clearly see elevated volume and upward price movements. As price approached the area of resistance, we can see that the buyers backed off, which is shown in lower volume, because they waited for the sellers to jump into the picture and cause price to pull back some. However, the sellers were scared of all the volume they just saw (like myself who was not willing to get short (
here) so price was only able to pull back ever so slightly. When the buyers realized this, they all jumped back into long positions or got into new long positions, and added to the demand and volume at this given area.

Following this event, we saw price break right through resistance and do so quite strongly, leaving us with a picture perfect trade.

Through just this one example, I hope you will not only have a slightly better understanding for what volume is and how I use volume, but more importantly I hope you will start to use volume in your trading if you are not already. I truly hope you will be one of the few traders out there that actually uses volume properly. There are thousands of factors that can influence the outcome of any trade that you place, and by adding volume to your trading edge you just have that much more of an advantage over every other trader in the markets.

Brendan Egan can be contacted at 123LearnToTrade

Brendan Egan is a seasoned US equity trader who was trained, in part, by former floor traders at the Chicago Mercantile Exchange. Brendan bases his trading decisions by strictly using price action trading techniques (which is only looking at price and volume movements). Realizing that there is a major lack of information about how the market actually works and how professionals trade, Brendan set out and formed 123LearnToTrade.com which offers video courses and private mentoring to help those wishing to trade like professionals.

Brendan Egan is a seasoned US equity trader who was trained, in part, by former floor traders at the Chicago Mercantile Exchange. Brendan bases his t...

timsk

Legendary member
6,971 1,831
The article is a good basic introduction to volume, but it doesn't address one fundamental problem faced by most traders when evaluating the relationship between price and the standard volume histogram like the one used in the article. Namely, the ability - or inability - to distinguish easily between the different types of volume.

For example, the histogram prints a large bar and is accompanied by a large bull candle. The obvious conclusion is that demand is greater than supply, thus causing price to rise. However, what it doesn't tell you is whether the volume is created by new buyers entering the market or short sellers buying to cover. The reverse applies to volume that accompanies a bearish price move: is it fresh shorts entering the market or long holders closing out their positions? The distinction is an important one because a bull rally fuelled by short coving can quickly peter out when the shorts have closed all their positions. So, in such cases, a move up isn't the result of demand at all, merely a desire to get out of the market with a profit or to minimise a loss. Moreover, those market participants that are able to make the distinction between the different types of volume will then be able to initiate new short positions at a higher price and repeat the same exercise all over again.

If Mr. Egan would care to outline how we can make this distinction, then that really would be a valuable contribution!
;)
Tim.
 
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Splitlink

Legendary member
10,850 1,232
The article is a good basic introduction to volume, but it doesn't address one fundamental problem faced by most traders when evaluating the relationship between price and the standard volume histogram like the one used in the article. Namely, the ability - or inability - to distinguish easily between the different types of volume.

For example, the histogram prints a large bar and is accompanied by a large bull candle. The obvious conclusion is that demand is greater than supply, thus causing price to rise. However, what it doesn't tell you is whether the volume is created by new buyers entering the market or short sellers buying to cover. The reverse applies to volume that accompanies a bearish price move: is it fresh shorts entering the market or long holders closing out their positions? The distinction is an important one because a bull rally fuelled by short coving can quickly peter out when the shorts have closed all their positions. So, in such cases, a move up isn't the result of demand at all, merely a desire to get out of the market with a profit or to minimise a loss. Moreover, those market participants that are able to make the distinction between the different types of volume will then be able to initiate new short positions at a higher price and repeat the same exercise all over again.

If Mr. Egan would care to outline how we can make this distinction, then that really would be a valuable contribution!
;)
Tim.
Hi, Tim,

Before internet, in the days when I used to buy the FT, there used to be a box in the data section that showed the bargains made the previous day on the FT100.

A person called Eustace Storey who was, himself, a stockbroker, wrote a book on a system that he had created. I bought that book and still have it, tattered and torn, on my shelf. It was one of the inexpensive systems around and I am sure that he wrote it for personal satisfaction -- not for financial gain.

His idea was that the volume of shares was less important than the bargains done, because an individual would make a trade according to the size of his budget. The trade size, large or small, is important to every trader, regardless of the number of shares.

So, a wealthy trader, buying several million shares over four trades would have, perhaps, less significance than a dozen smaller traders buyng the same amount over the same period.

In those days the trader did his own charting and Storey used a system called "Price plus Volume" which should have been called "Price plus Bargains" and it was quite easy to plot, just like P&F, but the number of bargains was added to the top and bottoms of the columns.

Maybe I could scan one of the diagrams and send it over although this information is not available now and is purely academic.

My point is that I agree with you, Tim, volume information is missing something and I believe that the number of bargains published provided the needed part.
 

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