Uncategorised

Volume Analysis

Understanding the way volume affects the market is key to successful trading, as price signals won’t always tell the whole story. Professional traders have one advantage over the private trader: they can read volume. Not only that but they can – and will – hide volume from you to give themselves an advantage. Large banks and brokerage houses claim that to make a market, they need an edge over the rest of the crowd. Large orders that are processed do not appear on the tape, as they would show up on the radar of other professional traders who would then change their bid/offers or pull orders. 

The professional trader uses price and volume, and usually no other indicator, to read the true balance of supply and demand, as Richard Wyckoff preached at the turn of the century. The study of price and volume and their relationship is vital to detect turning points in the market, as professional operators have large amounts of capital and need to work this capital to make money. This cannot be done by buying at the market or limit orders as it would destabilise prices, causing an unreadable situation.

‘Whip-sawing’ – prices marked rapidly up and down – is used to shake out the crowd and catch stop losses, but the real reason is to process large orders while covering any strategy and not giving the game away at the same time. When the market starts to trend, we say the large operators have control. They know that there are thousands of stop losses out there waiting to be triggered. This gives them the opportunity to process large orders and conceal their true intentions as they attract other traders, who can see their actions and act immediately to better their own accounts by reading volume. For example, ultra high volume on a down bar should stop the decline, with demand swamping supply.

The other advantage professional traders will have is the news: they will already have positioned themselves in advance of news and will try to wrong-foot as many traders as possible, gunning for stop losses and misleading the crowd into thinking the opposite of their true intentions. Why is it that bad news always appears in the last two weeks of a bear market and good news always at the top of a bull market? It is done to put you under pressure at the bottom and to make you hunger for more at the top of a bull market. This allows the operators to unload large blocks of stock or futures contracts at the best possible prices and to reaccumulate at the bottom to increase profits – usually at a large loss to the crowd. The cycle is then repeated over and over, giving us bull markets and bear markets – which is why you are bombarded day and night with news on earnings, unemployment and payrolls.

These operators know that you are ruled by three things in the market: fear, hope and greed. Fear of missing out, hope that when you are losing prices will recover and you can close out at break-even and greed that when you have a profitable position you hang on for greater profits and often fail to see the tide coming in.

By studying volume and its relationship to price, you can begin to detect subtle changes in supply and demand. You will see when the large operators are active and, by observing the results of their actions, you should begin to see a picture of the ongoing market unfolding before you in a trading session. Let’s say you are sitting in front of your computer one day, watching a bar chart, and you see a large amount of volume on an up bar. You will – because you have been told this is so – assume that strength always appears on up bars and weakness always appears on down bars. But in fact, up bars with excessive volume are a sign of weakness, as down bars with high volume show strength.

But how can this be true? Imagine you are an institution with a large block to dispose of: how can you do this without moving the price against you? Answer: by marking up the price to bring in buyers. Rising prices create demand, demand does not create rising prices. If you see prices rising, you are more likely to buy than sell as you will expect to make a profit as prices continue to rise. But if you cannot read volume, your image of these rising prices will distort the true picture: you will not see the excessive volume indicating weakness.

Reading one bar in the chart does not give you the complete picture, so further careful observation is necessary. Does the market top out and do prices start to fall back? If so, this could indicate that supply has swamped demand, capping the top of the market. But it might also only be the start of distribution. One high volume up bar on its own does not create a bear market but usually marks the start of supply. By reading the volume, it is possible to detect when the large operators have been active and whether their opinions have changed, probably turning bearish. If you cannot read volume, you are likely to think the market will keep rising and may buy on the reactions. The institutions, however, will be aware that the crowd is soaking up all it can and will artificially hold prices up until all has been unloaded. That point will be characterised by a low-volume up bar (signifying no demand), indicating to the large operators that the buying has dried up and the mark-down can begin. The opposite would be true if the operators have marked prices down far enough and can cover at a large profit – usually at a loss to the crowd, who are now panicked into selling in fear of even lower prices, usually on bad news. And so the cycle is repeated, over and over.

Professional operators move in and out of the markets at various times. The following two charts show trading on the S&P E-mini futures contract and each bar represents 30 minutes. The first chart shows high volume with professional activity, which is highlighted. The second chart shows no activity. This is as important as professional activity because markets work both on supply and demand and on no supply and no demand.

Professional Activity
caption: Professional Activity

Non-professional activity
caption: Non-Professional Activity

By reading the volume with price, you can learn to trade successfully in any time frame as you will begin to know enough to distinguish the real movements from the false ones. There are a lot of false drives in the market which are deliberately done to trick you into losing money. This is how the professional operators stay in business. But by understanding the different intensities that appear in the market, you can make money too. All you have to do is follow the big operators: when they move, you move too. So, you may ask, all I have to do is sit back and wait for the operator to tell me when?

Unfortunately it’s not that simple. Because volume is the powerhouse of the market, we have to observe the corresponding price action: is there an old trading area to the left on the chart, say an old high or an old low? If you see low-volume down bars with a narrow spread, then this would indicate that the professional operators were bullish and that they would be willing to absorb the supply as they reached the old top. However, if you see low-volume on up bars as the market approaches the old top, then this would indicate that the market was weak and it would be fairly safe to short near this level.

This would also be true for trend lines. Trend lines are the railroad for prices when the market is trending strongly and we would be looking for support or resistance as these trend lines are approached. For example: if you see a wide spread on increased volume as it approaches an old trend line (or old top or bottom), you can expect this to be broken. But if you see no demand (weakness) or a test (strength), it will not be broken: you can place your orders and make a profit as you can read the path of least resistance.

Imagine the path of least resistance to be water running down a hill. It would not just run down in a straight line, it would twist and turn if obstacles were in its way – so the path of least resistance would be the easiest path, not necessary the quickest one. This is how the operators mark prices round to find volume. If there are large orders at a certain price, the operator might avoid that price level as it would mean he would have to absorb this supply at higher levels – a quick way to go broke. This is why we have shakeouts and whip-sawing in the early stages of a rally, because it is not cost-effective to absorb ever-increasing supply at higher levels. Volume holds the key to the truth.

(This article is reproduced with the kind permission of Shares Magazine).

frugi

1
1,827 125
In this article Sebastian Manby discusses his take on classic Wyckoff principles regarding the study of price and volume patterns.
 

jmreeve

Well-known member
432 13
Trouble is Wyckoff wrote these principles a long long time ago before markets were linked together with derivs, stat arb programs and heavily influenced by algorithmic trading. The price volume picture is not as simple as it used to be.
 

dbphoenix

Legendary member
6,952 1,242
You're correct that it's not as simple as it used to be, but though the character of "volume" has changed, the principles haven't. They're derived from behavior, and that never changes (or hasn't, so far).

The most common error that people make here is the same error they make when "interpreting" candles: focusing on each bar or bar-pair or cluster as a discrete event. Whatever happens is part of what happened before and will affect what happens next. Therefore, focusing on the "waves" of buying pressure and selling pressure is far more productive than worrying about what this or that particular bar or bar-pair means. The market is a movie, not a slide-show.
 

Rhody Trader

Senior member
2,620 264
dbphoenix said:
The market is a movie, not a slide-show.
I can honestly say that's one of the best quotes I've ever read or heard. Well said!
 

dbphoenix

Legendary member
6,952 1,242
While beginners have pretty much the same problems year after year, there are also trends in problems. A current and persistent trend has to do with the widespread availability and use of charts, particularly during the last ten years. Two of the most damaging characterisitics of this trend are the tendency to view price movement as click click click and to read the chart from right to left, focusing on what's called the "hard right edge" and on predicting what's going to happen next. I'm far more interested in what happened prior to the "hard left edge" so I can get some idea of where traders are most likely to look for and find trades.

Wyckoff was very big on anticipating and planning but not so much on predicting. There have been endless discussions/debates/arguments about the difference and I don't want to deflect the thread. But an appreciation of the nature of the trader's task is helpful. Otherwise, he can find himself perpetually at the mercy of others.
 

remnent

Newbie
1 0
This article gives us a view of what professional activity looks like on a chart, I'm not sure how to use it in a trading methodology alone, I'm sure there's more to the story!
 

jmreeve

Well-known member
432 13
remnent said:
This article gives us a view of what professional activity looks like on a chart, I'm not sure how to use it in a trading methodology alone, I'm sure there's more to the story!
The chart is almost entirely the result of professional activity in most markets.
Private investors/traders count for a small part of the total volume and in practice
have very little impact on the market even in aggregate. The idea that volume
is anything like equally split between professional and non professional market
participants is just a fantasy.
 

newstart

Junior member
40 4
This article came just at the right time for me as I was looking for the answer to a few questions which it does perfectly
 

Skog

Member
74 8
newstart said:
This article came just at the right time for me as I was looking for the answer to a few questions which it does perfectly
Sebastian has also posted a few charts around here on the boards under the name VSATrader. Just use the search thingy to find his posts.

Here is also a website that might be of interest:

http://www.vsatrader.com/
 

Artful

Junior member
22 0
It is true, and it would appear that the only way to gauge market activity is to examine the Volume in relationship to the spread of the bar (High to Low). There is very little written about this concept. There are some markets that don't even supply the volume data.
 

dbphoenix

Legendary member
6,952 1,242
Actually, the volume need not have anything to do with the range. The volume reflects the amount of trading activity, the effort. The bar or candle or whatever reflects the result of that effort. The position of the close in relation to the O, H and L are at least as important as the range.
 

JumpOff

1
702 14
jmreeve said:
The chart is almost entirely the result of professional activity in most markets.
Private investors/traders count for a small part of the total volume and in practice
have very little impact on the market even in aggregate. The idea that volume
is anything like equally split between professional and non professional market
participants is just a fantasy.
Do you mean "all charts are almost entirely the result of professional......." or this specific example.

This article used the e-mini S&P as an example, and I am curious about that. I thought that professionals (fund managers who are required to keep large amounts of capital in an open position) rarely trade "mini" anything because of the higher transaction costs.

Trouble is Wyckoff wrote these principles a long long time ago before markets were linked together with derivs, stat arb programs and heavily influenced by algorithmic trading. The price volume picture is not as simple as it used to be.
Are the pros trading the regular S&P and the arb programs keep the e-mini S&P from getting out of whack with the S&P? Or has the e-mini tail started to wag the S&P dog as the result of higher volume and better liquidity on the e-mini?

Actually, I'm not sure how to compare the two. The S&P had a mean of 50,000 contracts traded through April, while the mini had a mean of about 750,000 contracts during the same time, - but the e-mini is only worth 1/5 of the full S&P contract. So the emini has a volume equal to 150,000 S&P contracts... that's 3 times the amount of the S&P full size instrument.

Well all that is a prelude to my real question. Isn't it true that because of the way the markets are linked, and the way that computer arbing programs work, that the most important thing to know about trading is: which instruments (if any) are "the dogs." If you are trading one of the wagged tail derivatives, you would need to watch volume and price on the dog, no?

I've asked something like this before, and feel the familiar overheating of my logic circuit breakers.... I think I'll trot off to a cool muddy spot and rest now.....

JO
edit: actually - I don't think those contract numbers are right , although the ratio between them should still be ok. I pulled them off a futuresource chart and there is no label saying what the scale of the volume is, - I mean does 50,000 equal 50,000 contracts, or 50,000 units of 1,000 each...? ow - now my head is really throbbing.... well it doesn't matter... Where is that shady spot ....?
 

neil

Legendary member
5,167 745
Your opinion is ok but

Diana432 said:
Some nonsense, some good points, but all traken from Tom Williams book.
I wouldn't waste time reading it.
I disagree, I have read it and found it extremely profitable such that I stopped using indicators and use p and v alone. ( OK I use a 39ema purely to focus my old eyes. But be aware it still takes a lot of study , chart observation and practice before you become profitable.
 

Similar threads