Why Volume on Stock Charts is a Vital Indicator

By Michael Cintolo, Chief Analyst, Cabot Market Letter and Cabot Top Ten Trader
From Cabot Market Letter 2/11/09

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.

Where are we seeing volume spikes in the current environment? Honestly, not that many areas … which is one reason you should go slow when the time comes to wade back into the market. If we saw dozens of stocks exploding to new highs (or new multi-month highs) on big volume, it would be a different story. But that’s not yet the case.

We like to find big volume increases across an entire group, which gives you confidence that a move is for real. An example these days is the for-profit education group; many have reacted well to their earnings reports, but the breakouts in this sector came a few weeks ago.

You can even use volume to spot potential turnaround situations. Homebuilders, for instance, are far from our favorite group, yet many stocks in the sector have leveled out for months, and just last week, volume spiked as investors looked ahead to (another) government banking plan, as well as possible housing help in the stimulus package.

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. 

If there are going to be big winners emerging, we expect volume clues to lead us to them in the weeks ahead, as institutions rush to build positions in the market’s next batch of leaders.

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