Volume as Secondary Indicators

Price is by far the most important. Volume is secondary in importance and is used primarily as confirming indicators.

Volume is the number of entities traded during the time period under study. The level of volume measures the intensity or urgency behind the price move. Heavier volume reflects a higher degree of intensity or pressure. By monitoring the level of volume along with price action, we are better able to gauge the buying or selling pressure behind market moves.

In general, volume should increase or expand in the direction of the existing price trend. In an uptrend, volume should be heavier as the price moves higher, and should decrease or contract on price dips. In a downtrend, the volume should be heavier during down moves and lighter on bounces. As long as this pattern continues, volume is said to be confirming the price trend.

By monitoring the price and volume together, we’re actually using two different tools to measure the same thing-pressure. Technicians believe that volume precedes price, meaning that the loss of upside pressure in an uptrend or downside pressure in a downtrend actually shows up in the volume figures before it is manifested in a reversal of the price trend.

The simplest and best known of volume indicators is on balance volume or OBV. OBV actually produces a curving line on the price chart. This line can be used either to confirm the quality of the current price trend or warn of an impending reversal by diverging from the price action.

To construct the OBV line, the total volume for each day is assigned a plus or minus value depending on whether prices close higher or lower for that day. A higher close causes the volume for that day to be given a plus value, while a lower close counts for negative volume. A running cumulative total is then maintained by adding or subtracting each day’s volume based on the direction of the market close.

It is the direction of the OBV line that is important and not the actual numbers themselves. The on balance volume line should follow in the same direction as the price trend. If prices show a series of higher peaks and troughs, the OBV line should do the same. If prices are trending lower, so should the OBV line. It’s when the volume line fails to move in the same direction as prices that a divergence exists and warns of a possible trend reversal.