Price and volume have often been regarded as the oldest and most beneficial indicators used while assessing market charts and are based upon the fundamental concepts of supply and demand. Volume trading has been used as a means of determining the collective interest of investors in the market. In a more specific terminology, it indicates the total amount of professional buying, selling or overall lack of demand shown by market participants and other corporate and financial institutions. Due to this, in terms of the value and reliability of indicators, volume is second only to price.
Stock chart volume is described as the number of shares traded over a specific time period and the main advantage of this indicator is its flexibility. Volume is illustrative of the level of interest in a stock and can be used for comparative purposes such as assessing a change from prior volume to current volume of the same stock, or from contrasting the volume of one stock to another. It is therefore a pivotal indicator for a trader to determine and reaffirm trends, breakouts or the possibility of a reversal. Volume has also been utilized as component in various other indicators that help in the analysis of the stocks.
Firstly, to understand the overall concept of volume and price trading, the relationship between the two needs to be examined and understood. Using the example of an uptrend for reference, it can be said that as the price moves in the direction of the trend, the volume will simultaneously increase correspondingly. A break in this trend, referred to as a counter move, results in a decrease in volume and as volume increases during that counter move even before price confirms a reversal of the trend, an indication of an ensuing reversal of trend is already evident. Thus, volume has enabled the anticipation of a reversal in trend, even before price values have guaranteed it. A following surge in volume compared to previous levels also often signals the end of a trend. Therefore, a high volume indicates a significantly large number of market participants that are directly involved in price action, while a low volume indicates little price movement and fewer participants who have hardly any interest in the price. In the case of prices rising while volume is decreasing, there is an indication that a trend may possibly be unlikely to continue and is thus valuable information to the trader.
Therefore, there are 3 main ways in which volume is used in concurrence to any form of price analysis and these include:
1.The ability to reaffirm a trend and its direction
2.The ability to identify a price reversal and its impact on a trend
3.The ability to identify a significant price breakout and its overall impact on the trend direction
The ability to reaffirm a trend and its direction:
In a visual downtrend, volume increases as price declines. Therefore, if you are shorting the trade, rising volume helps to confirm the direction of the downtrend. In the alternate situation of the trader being long in the same downtrend, rising volume of the price decline indicates that the price may continue to drop and that it may be time to exit the position.
The ability to identify a price reversal and its impact on a trend:
When volume reaches a climactic peak level that is a drastic change from its typical average volume, it may indicate a change in price levels from the prior trend. This may result in a change in direction of the occurring trend, due to the fact that buyers and sellers are no longer pushing the prices in the previous direction. Therefore, it can be said that a climactic volume results in price reversals.
The ability to identify a significant price breakout and its overall impact on the trend direction:
Volume can also be used to identify price breakouts. Support and resistance values are important while identifying this, as an increase in price value above the resistance value and below the support value, with a volume larger than the average, proves that a breakout is likely to be valid and reliable. However, on the other hand, a similar situation differing in the lack of adequate volume, reveals that a possible breakout is unlikely and most probably unreliable in changing the overall direction of the trend.
The benefit of using price and volume in comparison to other indicators is its ability to provide perspective for the trader. For example, a break in an uptrend may indicate the possibility of a break in the entire uptrend and a resulting downtrend. However, after referring to the volume, which may indicate that the break in the stock did so on 70 percent less volume in comparison to the total volume, it is more likely that the previous uptrend may continue despite this break. This also allows for predictions and anticipations while analyzing the direction of the charts. An exception to the above explanation is the idea that within a possible trend that moves in one direction, like in a downtrend of a bear market, as the trend progresses, it is possible for the volume to continuously increase despite the breaks in rallies.
Therefore, it can be seen that volume is only a means for insight which then needs to be further confirmed by the value of price, thus allowing the trader to make an informed decision on the buying and selling of stocks. From a practical perspective, volume and price allow a trader to determine and predict the outcome of trend directions and from a psychological perspective, it provides confidence in the decision-making process. However, like all concepts, volume and price usage as indicators have certain disadvantages as well. For example, in certain cases, volume is not always in concurrence with price. This is evident in the case of a small price range, buying at the top of this range or selling at the bottom, may not be accompanied by a change in volume near the support and resistance levels, thus proving that a breakout and a change in the trend is unlikely to occur, as per the aforementioned explanations. Yet, this is not accurate as an ensuing trend reversal may occur despite the apparent lack of change in volume. In conclusion, despite certain limitations, volume in price trading is an essential and beneficial component in trend analysis and can be an effective indicator for traders while assessing market charts.
If you are new to trading and don’t have a solid understanding of various trading concepts, check out our free tutorial Teach A Man To Fish – A Foundation To Technical Trading.
Ananyaa Sreekumar – Content Marketer at Tradonomix.