Principles of Volume Interpretation

Volume not only measures the enthusiasm of buyers and sellers, but it is also a totally independent variable from price.There are three principal benefits from monitoring volume. First, when we look at indicators that measure both price and volume momentum, it is possible to see if they are in agreement. If so, the probabilities favor an extenstion of the prevailing trend. Second, if they disagree, it tells us that the underlying trend is not as strong as it might appear on the surface. Finally, volume often throws up chracteristics of its own that literally shout the message of an impending trend reversal.

Principles of Volume Interpretation

1. The most important principle is that volume typically goes with the trend. It is normal for activity to expand in a rising market and contract in a declining one. In this sense volume is always interpreted in relation to the recent past.

2. One important aspect to consider is the fact that volume reflects an exchange between buyers and sellers.

3. If buyers get greedy, they will push up the bid until they obtain as much quantity as they want. If sellers react to bad news, they might panic, pushing prices down sharply, but at all times the amount of a security being sold is always equal to that being purchased.

4. Rising volume and rising prices are normal. This combination indicates that the market is in “gear” and has no forecasting value. If this is the case, it is reasonable to expect at least one more rally that reaches a new price high when volume does not.

5. Volume normally leads price during a bull move. A new high in price that is not confirmed by volume should be regarded as a red flag, warning that the prevailing trend may be about to reverse.

6. Rising prices and falling volume are abnormal and indicate a weak and suspect rally. This type of activity is also associated with a primary bear market environment and can be used as an indicator in this respect. Just remember, volume measures the relative enthusiasm of buyers and sellers. A market that rallies on a trend of lower volume indicates that prices are rising because of a lack of sellers rather than the enthusiasm of buyers. Sooner or later the market will reach a point where sellers become more motivated. After that, prices will start to pick up on the downside.
7. Sometimes both price and volume expand slowly, gradually working into an exponential rise with a final blowoff stage. Following this development, both volume and price fall off equally sharply. This represents an exhaustion move and is characteristic of a trend reversal.

8. The opposite of a parabolic blowoff is a selling climax. A selling climax occurs when prices fall for a considerable time at an accelerating pace, accompanied by expanding volume. Following a selling climax, prices may be expected to rise , and the low established at the time of the climax is unlikely to be violated for a considerable time. A price rise from a selling climax is by definition accompanied by declining volume.

9. When prices advance following a long decline and then react to a level as slightly above,or marginally below, the previous though, it is a bullish sign if the volume on the second trough is significantly lower than the volume on the first. There is an old saying on Wall Street:”Never short a dull market.” It applies very much to this type of situation in which a previous low is being tested with very low volume. This indicates a complete lack of selling pressure.