Volume is one of the most important technical analysis tools to learn and understand how to apply to price movements. Volume increases every time a buyer and seller transact their stock or futures contract. If a buyer buys one share of stock from a seller, then that one share is added to the total volume of that particular stock. Volume has two major premises:
- When prices rise or fall, an increase in volume is strong confirmation that the rise or fall in price is real and that the price movement had strength.
- When prices rise or fall and there is a decrease in volume, then this is interpreted as being a weak price move, because the price move had very little strength and interest from traders.
The chart below of Gold futures shows a strong trend being confirmed by a strong increase in volume:
The chart above of Gold shows that when prices began making new highs, volume increased. As the price of Gold increased, more and more buyers (buying pressure) jumped on board.
Likewise, if prices are heading downward and are making new lows and volume increases, the sellers are becoming more and more interested as price falls (increased selling pressure).
Importance of Volume when Analyzing Price Movements
The following is an extreme illustration of the importance of volume:
- A buyer places a market buy order after hours for 10 shares of stock. The transaction occurs one dollar above the closing price. Therefore, the one dollar price move had 10 shares worth of interest from a buyer.
- A buyer places a buy order for 100,000 shares of stock. This transaction takes place at a price that is one dollar above the current price.
Which example is more bullish? They both increase the last transaction price by one dollar. If a trader didn't use volume, he/she would think that the move was identical from a price chart perspective. Of course, the second example is more bullish because the one dollar more the buyer of the 100,000 shares is willing to pay is significant (the buyer is bullish and is taking a large bet to prove it); whereas, in the second example, 10 shares is insignificant.
Increases or decreases in price along with increased volume isn't always confirming of trend. Volume blow-offs are discussed on the next page.
