Why Study Volume?
Most traders know that volume data can be used to asses the
prevailing market sentiment. But why study volume? Why is it that the market
frequently reverses the course after one (or several) large volume surge?
Let us revisit the definition of "volume":
Volume is the number of shares, traded during a given period, for a security or an entire index or exchange.
Volume data simply shows how many shares were transferred from one group of investors to another and the proper analysis of a past volume action allows analysts to anticipate its likely future trends. Following a phase where the market has seen volume increase substantially in a short time indicates that a large number of shares are being transferred (i.e., distributed) from one group of market participants to another; it is at this point that the market can become "overbought" or "oversold". By analyzing this volume surge (how big it is, how far away it is from a previous reversal point, how prolonged in time it is), you can anticipate when the market is likely to reverse in the short-, mid-, or long-term.
Generally speaking, the price moves down due to the selling pressure that is bigger than buying. The larger than average amounts of volume to the price downside indicate increase in buying pressure that tries to satisfy demands of sellers. Due to this increase in buying pressure, a price may reverse its movement and begin to move higher. The opposite is true about volume surges to the price upside that may cause a price reversal up. As a rule volume surges always precede price trend reversals.
| Chart 1: Price movement and volume relationship |
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©HGH Associated Press
5/25/2006
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