Article The Hidden Strengths of Volume Analysis – Part 2

[T2W Bot]

In part 1, I discussed two examples of how and why volume can show the changing face of supply and demand. When the order of supply and demand is change we will get a change in market direction, sometimes a significant change in trend or otherwise some degree of retracement of the prior move. We will now continue on from that discussion and show larger periods of transition which can lead to quite substantial turning points in the major trends. These can be easy to identify, but do require some patience. If you did not read the prior article it would now be worth reviewing that before going on.
Let’s firstly take a look at AWB Limited.

Since early 2006, the price of AWB had been in a downward spiral. The story that eventually came out suggested AWB was doing some bad business against the UN sanction in Iraq. The initial shock sent the shares plunging by 18% in a single week. 
This is a sure sign of a change...

Continue reading...

 

[wallstreetwarrior87]

Hi Nick, once again some nice points for discussion.

I would like to ask a few questions if thats ok?

It is nice of you to do an analysis like this, but can you actually mark down on the charts where you would take your trades based on your reading of volume analysis. That way others can have a better grasp of what you are seeing. If not then this becomes nothing more than pointing out the obvious.

Capitulation is where traders are chasing what others have. It is the final sequence of a cycle. Yet you state that capitulation comes in the form of a down move? (Bar 1 on the 2nd chart).

So if it is not capitulation, what is it then? Again for the benefit of other readers, the price on the left hand side is the top of the market, so price has been driven up prior.

In bars 4 and 7 you suggest smart money is buying here ( I presume you mean accumulating), but is really the case. Look at what happens after, a move that tops out at about 4.80. Is smart money really going to be in a position for 4 months only to get price to this level? Does your volume analysis over the following months confirm this to be correct?

There is a lot of talk about "smart money", what actually is this, and what therefore is "un-smart money"

Those are just a couple of points to start with. Would be good to get some feedback.


Thanks

 

[Nick Radge]

Let's take a look at a current example. This stock, QBE Insurance (QBE.AX), has been a market darling for many many years yet has slowly been trending lower from about $28. Note back in August last year the stock moved to new lows and points 'a' and 'b' we see large volume days, both of which are wide ranging and both of which have high closes. The high closes mean buyers are in control - no other way to look at it. However, the signficant volume also means there was a lot of seller pressure. This does not portend a significant low because there has been no real ' capitulation' as yet. However, it does suggest there is 'background strength' or buyer demand of value.

Now, to just go off topic for one second it's important to appreciate how these insto buyers operate. Their analysts will velaue stocks and offer an appropriate area to start purchasing, something along the lines of, "...if you can buy QBE below $14 you'll doing good". Obviously we don't know what that exact value level is but that's how it works. Considering that strong demand can be seen an 'a' and 'b' we can have a decent understanding of where perhaps that buyer level is.

Now, this is not to say the stock can't travel lower which bring me to my next point being that a turn around in a sustained trend is a 3-stage event. Stage-1 is a point of capitulation, which on this chart is at 'c'. We had a significant earnings event, a large gap lower, wide ranging bar, massive volume and a high close. Now the important point here it has happened with the background strength of 'a' and 'b'. Its added confirmation to our theory that buyer demand is at these lower levels. Stage-2, after capitulation, is where the 'hangers-on' slowly get bored of the underperfoming stock and slowly bail. They held through the capitulation in the hope of a quick rebound, but with no rebound they get bored and slowly exit. Stage-2 is the start of a base building exercise where the buyers are unwilling to pay up but are willing to sit back and absorb supply from bored holders. Volume drops in stage-2, as can be seen at 'd'. This stage can take 6 - 12 months to unfold but it does highlight, in conjunction with the capitulation and backgrouns strength, that a significant low is in place. Stage-3 occurs when all supply has been exhausted and absorbed by the buyers then the stock is ready to start moving higher. We'll know this when we start getting high closes on low volumes - meaning no selling pressure.

So to answer the question, there are two ways to trade this. Take an immediate long position after 'c' and expect prices to rotate back and forth in a range. I have been suggesting that this stock could rotate as high as $13 in the short term. For longer term buyers I suggest partial positions be taken anytime. I say partial because this stage-2 base building can extend for a number of more months. Once volume is consistently low and closes are consistenly high in the sessions range then perhaps stage-3 is upon us.

 

[Nick Radge]

Another good example is the following chart of the broader Australian market. In July last year we saw a significant and swift decline of some 17% which culminated in a massive wide ranging bar with the close at the sessions high and a 50% increase in volume. This is the buyers meeting the capitulation and is now a strong foundation for prices to start moving higher. Its stage-1. Stage-2 is no under way. We're building a base and the probabilities are that the lows of last July/August will NOT be penetrated.

How to trade it? This being the broader market barometer and it suggesting no new lows will be in place, what we're looking for are higher beta stocks that are trending higher and showing strong relative strength. There are many of these available. Essentially we're taking the background strength of the market as a supportive indicator then drilling down to the constiuents that show the early signs of upward momentum to trade.

 

[wallstreetwarrior87]

Let's take a look at a current example. This stock, QBE Insurance (QBE.AX), has been a market darling for many many years yet has slowly been trending lower from about $28. Note back in August last year the stock moved to new lows and points 'a' and 'b' we see large volume days, both of which are wide ranging and both of which have high closes. The high closes mean buyers are in control - no other way to look at it. However, the signficant volume also means there was a lot of seller pressure. This does not portend a significant low because there has been no real ' capitulation' as yet. However, it does suggest there is 'background strength' or buyer demand of value.



Now, this is not to say the stock can't travel lower which bring me to my next point being that a turn around in a sustained trend is a 3-stage event. Stage-1 is a point of capitulation, which on this chart is at 'c'. We had a significant earnings event, a large gap lower, wide ranging bar, massive volume and a high close. Now the important point here it has happened with the background strength of 'a' and 'b'. Its added confirmation to our theory that buyer demand is at these lower levels. Stage-2, after capitulation, is where the 'hangers-on' slowly get bored of the underperfoming stock and slowly bail. They held through the capitulation in the hope of a quick rebound, but with no rebound they get bored and slowly exit. Stage-2 is the start of a base building exercise where the buyers are unwilling to pay up but are willing to sit back and absorb supply from bored holders. Volume drops in stage-2, as can be seen at 'd'. This stage can take 6 - 12 months to unfold but it does highlight, in conjunction with the capitulation and backgrouns strength, that a significant low is in place. Stage-3 occurs when all supply has been exhausted and absorbed by the buyers then the stock is ready to start moving higher. We'll know this when we start getting high closes on low volumes - meaning no selling pressure.

Hi Nick, thanks for the reply.

I understand some of your points here and agree with some of them, but there are a lot of inconsistencies in the way you are marking/analysing the charts.

I have highlighted 2 comments (one in blue and the other in red). If we look at the red comment. I suggested to you that maybe your definition of capitulation was incorrect in your last article. In this you state that the big down bar after a sustained move up was capitulation, but on the chart above (QBE) you say capitulation is at the low of this market. So does this mean that your call on capitulation on AWB was wrong?

Precision is very important when using terms in the market. If you do indeed see both of these as capitulation then you can not be reading the market in a consistent manner, as these scenarios are totally different.

The second comment in blue; It is very dangerous to make a statement like this. You state this "The high close mean buyers are in control - no other way to look at it" as a fact. So I will offer you an alternative; A heavy squeeze day! A squeeze day does not mean buyers are in control. In fact the players that are in control of that current cycle may not even be participating here (apart from at the open), and this will not be to accumulate any positions at this point. I can think of a few others but will not go deeper into it at the moment.

Have you considered that a lot of this analysis maybe upside down? You only appear to look at the market from the "smart money" POV (please correct me if im wrong). Yet we still do not have a summary of what "smart money" and "dumb money" (if thats the opposite) is yet.

I am not trying to be argumentative here , just trying to understand your theory/reasoning. Its just that, for this to benefit anyone (especially those new to volume analysis) the analysis must be consistent. You can not call capitulation in the middle of the range (as you have done on AWB), yet it is called at the end of the move on QBE.

I will suggest that the area on AWB that you refer to as capitulation is in fact actually an aggressive mark down phase. Even easier to tell as we have the next years price movement infront of us

Thank you again for the posts, it is a very interesting area of discussion.

 

[Nick Radge]

I'm not sure I agree with the term 'dangerous' when it comes to decison making in the markets. It implies a degree of certainty, of which there is none. Decision making is about probabilities which are either taken from a systematic or quatitative simulation or from experience. In this example it comes from my 26 years experience. Regardless, its still about probabilities and with that comes the possibility (if not probability) of being wrong.

Any type of analysis is open to interpretation, unless of course if its systamatically quantifiable. What is presented here is not, therefore open to interpretation. Exactly what constitutes a trend? What constitues a range? How I define and how someone else defines these factors is why the world goes around. We all swim in our own pools of logic and if it were any other way then the market would not exist as it does.

I appreciate the open feedback and discussion.

 

[wallstreetwarrior87]

I'm not sure I agree with the term 'dangerous' when it comes to decison making in the markets. It implies a degree of certainty, of which there is none. Decision making is about probabilities which are either taken from a systematic or quatitative simulation or from experience. In this example it comes from my 26 years experience. Regardless, its still about probabilities and with that comes the possibility (if not probability) of being wrong.

Any type of analysis is open to interpretation, unless of course if its systamatically quantifiable. What is presented here is not, therefore open to interpretation. Exactly what constitutes a trend? What constitues a range? How I define and how someone else defines these factors is why the world goes around. We all swim in our own pools of logic and if it were any other way then the market would not exist as it does.

I appreciate the open feedback and discussion.

Hi Nick, thanks for the reply.

The thing is, it was your comment that implied certainty, as you said "there was no other way to look at it" with regards to buyers being in control. I offered an alternative, but it seems to have been ignored? In fact I could offer another couple of alternatives, that would still conclude that buyers were not in control at the point you said they were. Indeed, if you look at the following 2 days it proves buyers were not in control!

So we have to use the evidence in front of us to confirm or deny our analysis. So it is not really open to interpretation here as you can see the outcome, there for you have "fact". So we need to now ask why the market fell again after this apparent "smart money buying event". So they must have been buying for another reason no? (notice i say someone was buying, but i am not saying they are in control). This is why price does not rise from this point.

So what could the volume at point A on QBE really reflect? The problem here is that only large volume is been noticed or been allocated importance on these charts. "Smart money" is heavily involved in at least 3 other areas on the QBE chart, which goes un-noticed by the majority, this is because it does not stand out in relation to high volume levels.

Of course if we keep stating that smart money is involved when we see heavy volume we will eventually get some part of the analysis correct.

What traders really should be striving for is an opportunity where there is no debate of being open to interpretation. This means the need for clarity, and staying away from times in the market that may temporarily deflect us away from clarity (ie new events, reports etc). And in the event of a catastrophe a stop is in place because nothing is 100%.

Bottom line; we should ask ourselves the real reasons we would want to trade if events in the market are open to interpretation. This ultimately would help traders progress far quicker than trying to learn something they dont understand.

There are all sorts of edges available to the individual, some small and some large, so its really upto the trader to decide what they want and how they will get it.

I guess this is what makes the market the apparent jungle it is.

Thanks

 

[Nick Radge]

An update of that QBE example above. Prices have continued to push higher. I wouldn't be surprised to see a range develop now.