There is debate among some market observers who say that price is the only thing to consider when buying or selling a stock. They would have you think there is little or no correlation between price and volume levels or the amount of trading activity near price.
The intelligent stock market observer knows that trading volumes are an important characteristic of market health.
Trading volumes are the blood that pumps through the arteries and veins of the markets. (Sorry about the physiology analogy there) If not for trading volume the market itself would cease to exist. Understand, this one simple concept, if not for volume or the interest in traders and investors to own stock there would be no stock market at all. What drives the trading volume, the possibility of, profit. Without the profit motive we would have no reason to trade stocks, bonds, commodities, or other investment instruments.
Trading volumes give us strong indication of the psychology affecting traders at a given time in the markets.
1. In a market that is trending up volumes will begin to pick up as other traders / investors see that other traders are coming into the market. More traders / investors coming into the market and buying stock will inevitably push prices higher.
2. In a market that is trending down volumes will begin to pick up as other traders / investors see that other traders are beginning to leave the market. More traders / investors leaving the market will inevitably push prices lower.
3. In a sideways or consolidating market trading volumes are generally modest and lackluster. This is characterized by prices that oscillate within a limited range. There is no clear indication of dominance by either buyers or sellers. As a result we have a tug of war that resembles somewhat evenly matched opponents pulling on a rope on the beach and trying to pull the other over the line drawn in the sand. For our purposes here the proverbial line in the sand is the price range top to bottom that this tug of war produces.
Commonly these price ranges are equal to 10% or so of the price of the stock or security. There are many examples that would defy that statement and we are not trying to prove every exception. Some stocks are very volatile, even, in their trading ranges and can exceed that threshold. Learn to identify these areas and you can profit.
Trading ranges almost always lead to large runs up in price or down in price. Trading ranges exist for a reason as they are the "lull before the storm". A trading range can develop over a period of days, weeks, months or years. The longer the development period the stronger the move in either direction will, generally, be.
These trading ranges generally indicate a period of quiet accumulation or selling and occur somewhat under the radar. This quiet period does not get swing traders or other short term traders excited about the market as it appears that nothing of significance is occurring. For those investors that sense much higher or lower prices are in the offing this presences a unique opportunity to build a position in a stock that can make them substantial sums of money if they are correct in their assumptions and timing.
In another piece we will detail some of the characteristics of volume patterns in charts and hopefully help make sense of it for those of you that are new to volume interpretation.