Discussion 10: Volume Sparks Interests

As most of us know, technical traders do not rely solely on Candlestick Patterns. Usually, there are more than candlesticks that are plotted on the charts. In my previous Discussions, I have repeatedly stressed the importance of Volume in confirming Candlestick Patterns.

Volume is the number of transactions that took place during the day. It should not be confused with Open Interests (which applies only to futures and options). A transaction involves a buyer and a seller. One buy and one sell, in this sense, constitutes to one volume.

So, why is volume so important? Volume shows the amount of interests in a certain movement. In other words, increases in volume means traders/investors are agreeing to the stock price, and therefore, they are more interested to transact at that price. Interests start to decline when traders/investors think the stock price is no longer attractive. At that time, volume starts to decrease.


VOLUME AND PRICE TREND

Volume Divergence

In a price uptrend, if the Volume does not increase with the Price (we say Price Action is inconsistent with Volume, or sometimes, Volume Divergence), then most likely the movement lacks interests from the traders/investors. In this sense, as smart traders, we will begin to tighten our stop losses, and take partial or all profits.

This is also true during a price decline. Theoretically, if Volume does not increase during a price drop, then the drop are lacking interests from the traders/investors, and very likely, a reversal would be taking place soon. However, due to fear prevails over greed, prices fall of its own weight! Established traders/investors would therefore pay more attention to volume decline at the top, and volume increase at the bottom, of a prevalent trend.

The table below shows different convergence and divergence combinations of Volume and Price:

Price	Volume	Remarks
Increase	Increase	Trending, with Conviction
Increase	Decrease	Trending, but losing Momentum
Decrease	Increase	Trending, with Conviction
Decrease	Decrease	Trending, but losing Momentum



Illustration (i) : TCHONG - Volume Divergence


Volume Behaviour in Trending Market
In an uptrend, prices tend to move up and then retraces to its support before making another leg of ascent. The reverse is true for a downtrend. Volume tends to make a hike when the price is trending, and then reduced when the prices consolidated or retraced to its support/resistance, and then makes another hike when the price continues its trend. A trend is usually broken when volume made consecutive highs in a retracement, and the price unable to make another higher low.

Illustration (ii) : KNM - Trend Broken

In illustration (ii), KNM was in an uptrend since end of November 2010. We can see that with each retracement, volume decreases. Volume then increased when the price trend resumed upwards.

In an uptrend, the tendency is to have the price making a higher high and higher low. Therefore, on 11/01, the new low created at RM3.01 was a support that KNM was expected to rebound off, if the uptrend were to continue. Unfortunately, on 21/01, the support was broken on a Gap Down, coupled with successive higher volume. Unable to make another higher low, the uptrend is confirmed to have been broken.

The price then hovered within the box, with the previous support of RM2.80 (created by the previous retracement low) and resistance of RM3.01 (support turned resistance). Both support and resistance were tested on numerous occasions, before the support was broken on 23/02. The drop on 24/02 in high volume was halted by the prior support of RM2.37 (created in previous Gap Up).

Taking a step back, you could already have seen this coming way back on 23/12. Since then, the volume has been making consecutive lower highs, while prices making higher highs. This constituted to a Volume Divergence, which signals the end of the uptrend is imminent, before it took place on 21/01 (approximately a month before it happened!)


VOLUME AND CANDLESTICK PATTERNS

Candlestick Patterns can be a Reversal, or Continuation Pattern. Volume plays an important role in further strengthening the signals derived from Candlestick Patterns. In seeking a volume confirmation, we always expect to see a convergence of Price Action and Volume.

For Candlestick Reversal Patterns, Volume on the candle itself or the next few candles is crucial to confirm the strength of the signal. We tend to look for high volumes in Candlestick Patterns as a strong signal confirmation. Subsequent price movements will most likely follow the direction of what traders/investors are more interested in. If the reversal candles receive more interest than the prior candles (high volume), then most likely, the bullish or bearish reversal signals generated are genuine ones.

Illustration (iii) : WCT - High Volume Confirmation

For Candlestick Continuation Patterns, Volume is almost associated with breakouts. Upon breakouts, high volume would confirm the success of the signal, with very little chances of the price falling back to the support/resistance.

[Note: We will discuss more on Candlestick Continuation Patterns in future Discussions]


VOLUME AND SUPPORT & RESISTANCE

As the price approaches support and resistance, most trader/investors will buy, or sell the stocks accordingly. While prices tend to range within the support and resistance, there are instances where such supports and resistances are broken, and the price then goes on a rally or dip. Volume acts as a useful indicator to hint such potential breakouts.

Due to the fact that support and resistance are hard to break, it is understandable that in order to break them, huge convictions must be in place. When a lot of traders/investors are interested in a price surge or dip, the probabilities of such support and resistance of being broken are greatly enhanced.

Illustration (iv) : WCT - High Volume Resistance Breakout

VOLUME AS CRYSTAL BALL

Volume, being magical as it is, may bring early signals of an imminent huge movement. This is particularly important when it happens on the intra-day chart. When traders/investors see a sudden volume spike in the charts (be it intra-day or daily chart), and there are no significant Price Actions on that candle, then traders/investors must be prepared for a potential big movement. It could mean that someone could be accumulating at that point of time, knowing that the price may surge or decline soon.

As the saying goes, "Volume Precedes Price".

Illustration (v) : FKLI 5-minute - 23/02

Illustration (vi) : FKLI 5-minute - 24/02

Illustration (v) and (vi) shows FKLI futures 5-minute intraday chart. The futures index made a sideway move. A significant spike in volume occurred but there were no significant Price Actions (candlesticks showed a doji). This gave a signal that the sideway trend was about to be broken and a huge movement is following up soon. True enough, FKLI futures made a breakout in the next few candles. This indication showed us a signal minutes before the breakout happened.


VOLUME BLOWOFF!

In a trending market, a sudden spike of volume may not necessarily signal trend continuation. Most of the time, when the volume spikes to an extreme high, accompanied by significant Price Actions, it may signal the end of the trend. Let me show you an example. Study the illustration below.

Illustration (vii) : OSK - Volume Blowoff

OSK made a sudden high on 06/01 with and unexpected surge of volume. Following that, the price went on a downtrend. This is due to the fact that during the extreme volume hike, those who wanted to buy the stock have already done so, now leaving only the sellers. Therefore, with supply more than demand, the price fell off its balance and made its way south.


In addition to candlesticks, traders/investors must also utilize Volume to assess the reliability of signals disseminated from the candlesticks. Volume, on its own, may not tell us much. Candlesticks, on the other hand, lack reliability. Combining volume and candlesticks would complement both tools' weaknesses, and at the same time, forging yourself a strong weapon for your trading success.

Happy Charting for the week ahead! Thank you for patronizing tlsinvestor.blogspot.com!