Volume Analysis
Chapter 6
TECHNICAL ANALYSIS
Volume analysis is a crucial aspect of technical analysis that focuses on analyzing the trading volume of a security. Volume represents the number of shares or contracts traded during a given period and provides valuable insights into the strength and conviction behind price movements.
Understanding Volume
Volume is an essential indicator in technical analysis because it confirms the validity of price movements. High volume during price advances or declines indicates strong market participation and conviction, while low volume may suggest lackluster interest and potential reversal signals.
Volume Patterns and Trends
Volume patterns and trends help traders identify market sentiment and potential trading opportunities. Some common volume patterns include:
Volume Spikes: Sudden surges in volume often accompany significant price movements and indicate increased market interest.
Volume Divergence: When volume diverges from price movements, it may signal potential trend reversals. For example, if prices are rising but volume is declining, it suggests weakening bullish momentum.
Volume Climax: Extreme spikes in volume near key support or resistance levels may indicate climactic buying or selling, often preceding trend reversals.
Volume Oscillators
Volume oscillators are technical indicators that measure the rate of change in trading volume over time. These indicators help traders identify changes in volume trends and potential shifts in market sentiment.
On-Balance Volume (OBV): OBV is a cumulative volume indicator that adds or subtracts the volume of each trading period based on whether prices close higher or lower. Rising OBV suggests accumulation, while falling OBV indicates distribution.
Volume Weighted Average Price (VWAP): VWAP calculates the average price of a security weighted by trading volume. Traders use VWAP to assess whether a security is trading above or below its average volume-weighted price, providing insights into intraday trends.
Example:
Suppose a stock experiences a sharp increase in price accompanied by high trading volume. This surge in volume confirms the strength of the price movement, suggesting strong buying interest. Traders may interpret this as a bullish signal and consider entering long positions.