Volume Based Technical Analysis
Volume by itself is only the number of shares transferred from one group of investors to another group of investors. By analyzing volume by itself, you can only track the change in the volume and see how active the trading is. Generally, volume by itself is used to analyze the activity of a stock in order to determine the stock's liquidity. The higher the average trading volume of a stock or any other security is, the more liquid this stock and security is. With greater liquidity, the stock or security is easier to buy and sell.
When it comes to analyzing the volume with the objective of defining possible trend development, the volume always should be analyzed in relation to the price. This is the basic concept of volume-based technical analysis, namely that- volume and price should be analyzed together. Only by analyzing each factor that affects the market (stock's) trend can you obtain a clear and complete picture of the current trend situation in real time and, based on it, make a correct prediction of further trend development.
The first and very important step is to get to know the price trend during the specific time frames in which volume is analyzed and decide whether the volume is bullish or bearish. One of the basic issues concerning price and volume is whether the volume occurred on the price upside or on the price downside. Below are a few close-ups of charts with different settings for up/down volume, where up- and down-volume (bullish and bearish volume) is defined in relation to the bar's close price:
up/down volume - off
price - line
Up/down volume - on
price - line
up/down volume - on
price - bar
On the chart examples above, you can see green and red volume bars classified as up- and down-volumes. A red volume bar means that the close price for the index was LOWER than the previous close price and, therefore, this volume is called down-volume. Conversely, a green volume bar means that the close price for that period was HIGHER than the previous close price and so this volume is called up-volume. Up-volume and down-volume are bullish and bearish volume, respectively, on the lowest level (on bar level).
Now, when the volume is defined as up-volume or down-volume, a trader or technical analysts may evaluate the money flow and determine whether the money is entering the market or leaving the market when the index volume is analyzed or into a stock or out of a stock when a stock's volume is analyzed.
At the same time, up- and down-volume permits you to see the actions of big institutional and professional traders reflected in volume surges (when a large number of shares changes hands). As a rule, a large volume surge on the price downside indicates that the large institutional investors, attracted by low barging price, are buying up the stock's shares that small investors are selling. Once all volume of this nature has peaked, the price trend generally begins to reverse and move up again. Similarly, the volume surge when the stock (index) price is moving up reveals that institutional investors, attracted by high priced stocks, have begun to sell (dump) their shares. It is generally the small investors who end up buying them, as they are hopeful that the stock market will continue to move higher.
In volume analysis, a volume surge acts as a signal of a change in the price trend. By using the up/down volume charting feature, you can easily see what part of the VMA surge is on the price upside and what part is on the price downside. Basically, the more red volume bars you see, and the higher the red bars are, the more likely it is that the stock market will reverse its direction and move upward. The converse is true for green volume bars.
NEXT: Types of Volume Analysis
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