The volume indicator is unassuming. It doesn’t tell you the trend or price levels. It doesn’t even tell you when to buy or sell. But it can warn you of an impending trend change, saving you from unnecessary heartache. How?
Volume (on any chart) tells you the number of shares traded in that period of time.
Let’s look at the daily chart of Facebook (FB):
And the weekly chart of FB:
What can you infer from volume?
I’ll use FB as a case study throughout this article.
2 Powerful Applications You Must Know
#1 Likelihood of trend continuation
You may have heard the saying “Success leaves clues”. There are clues to whether the prior trend will continue. Volume usually goes with the trend.
In a bullish market, volume should be high or increasing when prices are rising.
In a bearish market, volume should be high or increasing when prices are falling.
#2 Strength of the stock
The trend is your friend. You want to spot low risk areas to enter and then exit near the top. You need to know the strength of your stock in order to do that.
As volume indicates the number of shares being traded on that particular time frame, it tells you if there is momentum. If a thin 15-year-old boy approaches me to find trouble, I will not have any problem dismissing him. If a well-built 25-year-old man approaches me, I will definitely not fight back unless I want to lie in hospital for weeks.
When you see a divergence between price and volume, you know that the stock is running out of steam. The stock would either start to consolidate soon or change in trend direction.
Do you find the above paragraph familiar? Watch out for any divergence between prices and the Relative Strength Index too!
While in a downtrend, you will want to see increasing volume as price falls. The increasing volume indicates that shareholders are dumping the stock aggressively.
Combining volume analysis with chart patterns works wonders. Learn how volume validates chart patterns here.
Things You Must Remember
The trend and volume are your friends. You are in good company when they agree to each other. Reduce your exposure to risk by staying out of the market when they disagree with each other.
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