No discussion of technical analysis would be complete without a discussion of trading volume. By paying attention to a stock’s volume, you can pick up clues about where the stock price is headed. Here are four general rules about stock volume to keep in mind when you’re buying or selling:
1. When prices are rising and volume is increasing, the uptrend will likely continue.
2. When prices are rising and volume is decreasing, the uptrend will likely falter.
3. When prices are falling and volume is increasing, the downtrend will likely continue.
4. When prices are falling and volume is decreasing, the downtrend will likely falter.
"Churning" occurs when a stock’s price is relatively stable but volume is heavy. This situation must be watched carefully. One of two things is probably happening. The camp that was previously in control (bulls or bears) may be running out of ammunition. In this case, the churning is an early warning that a trend reversal is imminent. It’s also possible that the churning is nothing more than consolidation after a significant move in a stock. Only time will tell if a continuation of the trend is in the offing.
When there is huge volume of three or four times the daily average, the stock will likely do one of two things. First, if the big volume day occurs after a significant move in the stock, it may mark a change in trend. Let’s say the stock was falling on increasing volume. After several days of downward pressure, the bottom drops out of the stock and the trading volume skyrockets. This is known as a climactic selloff, and it usually marks the bottom in a decline.
Conversely, if a stock has been trending higher and trading volume spikes up as investors flood into the stock, that huge volume day may mark a top. The buying frenzy that occurs at the end of an advance may even create an exhaustion gap. But whether it does or not, a reversal is likely.
While many investors these days are familiar with charts in a general sense, too few pay attention to one key aspect of stock charts—volume.
Simply put, when the market finally gets going on the upside, paying special attention to outrageous volume spikes among individual stocks and sectors will allow us to clue in on the advance’s best winners, and help us avoid (or quickly sell) the losers. Huge volume spikes are an unmistakable sign that huge institutional investors are at work; they are so big they can’t hide their massive buying and selling actions.
And the good news for us is that these institutions generally accumulate (or distribute) shares over a period of weeks and months. So large increases in volume are your first clue that the deep-pocketed big-money crowd is beginning to jump onboard.
We like to find big volume increases across an entire group, which gives you confidence that a move is for real. You can even use volume to spot potential turnaround situations.
On the flip side, investors who ignore volume messages can hang on to a broken stock far longer than they should…and lose big money in the process.