VOLUME 1

By Daryl Guppy
SUBJECT SUMMARY
VOLUME
Volume is the fuel driving the
market. It is usually shown as a
histogram, with solid bars. Volume charts
yield clues when volume is out of
character. Unusually high, or unusually
low. High volume on a lower close
indicates selling pressure - people want
to get out and nobody is eager to buy so
the price falls. High volume on a higher
close indicates buying pressure - people
want to get in, but nobody will sell so
they have to bid higher. Volume
becomes erratic as the liquidity of the
stock falls. Large blue chips have high
liquidity - there are large scale trades
every day. A small speculative stock has
low liquidity - there are sometimes no
trades for days on end. Volume
significance depends on the normal
liquidity of the stock.

collection of volume tools.

Volume is one of the most elusive concepts in

technical analysis. In this series of articles we will
show how volume is better understood and combined
with other technical tools to provide a strategic
analysis of trend movements, sustainability and
change. We start with an overview of classic
interpretations of volume and then move onto more
modern combinations. It is important to understand
the limitations of existing volume analysis before we
can understand where new volume interpretations fit,
and how they overcome some of the limitations
imposed by existing volume analysis tools. The
implementation of this analysis rests on new analysis
tools.
We explore new analysis tools because the
old analysis tools fail to give us a reasonable way to
understand the relationship between trend and
volume. Although some are very good at establishing
the relationship between price and volume, this is not
the same as understanding trend behaviour. This
limits volume to a trading tool rather than an
investment or trending tool. We start with the existing

Volume has a vital role to play in immediate trading. This is the assessment of order
lines and volume behaviour in relation to very specific trading situations. Momentum trades are
the best example of this. Here the relationship between volume and price action is very clear.
Although this combination identifies an immediate and short lived trading opportunity, it does not
assist in understanding the broad trending behaviour of a stock. Volume in this sense is a
trading solution.

The broader relationship between volume and price is captured in specialist charting
displays, such as equivolume. Here the intention is to match changes in volume on a daily basis
with changes in price. The display is ugly and confusing. It is difficult to extract any particularly
meaningful relationship from this type of display. The intention is to identify trend change points.
We suggest that this has limited application because a trend change point is rarely a single
point in time. Trends develop and evolve. They do not suddenly emerge. There are times when
large volume is associated with a significant change in price, and a significant change in trend.
However, this trend change is difficult to separate from the short term momentum driven activity
shown in the first chart.

The On Balance Volume (OBV) chart is the next attempt to explore the relationship
between trending behaviour and volume activity. It compares the volume on up days with the
volume on down days and produces an accumulative value. All the volume in up days is added
to the accumulated total. On down days, all the volume is subtracted from the accumulated
total. (This ignores the fact that buying volume always equals selling volume). The indicator

attempts to track the impact of volume changes as measured by bullish or bearish activity. This
is a direct transition from the study of price activity where we are concerned with up days and
down days. Although we can smooth, or average, the OBV values, the result remains much the
same. We are measuring the activity of each day based on a buy or sell dichotomy. Buying and
selling on individual days does not give us the required information about trending activity.
Traders often combine OBV with other indicators to develop a better understanding of the
potential for trend change. However, the relationships do not appear to offer consistent results
or a significant edge.
An OBV application suggests that when the trends are broken on the OBV indicator that
this precedes a trend break in price because it captures the smart money flowing into our pout
of a security. These trend breaks are shown by the pink lines on the chart extract. Note that the
sharp rise in OBV captures the false breakout, and then signals an exit before the genuine trend
breakout occurs.
There are more advanced and complex applications of OBV, but this example highlights
several of the limitations to OBV. The first is the assumption that the balance of buying or selling
on individual days is significantly related to trending activity. Strong trends experience significant
downtrends within the context of the established up trend. The OBV indicator does not provide a
tool to distinguish between those OBV events which are an acceptable retreat within the context
of a major trend, or those which are a threat to the trend.
The second assumption is that there is a significant change in OBV relationships at the
beginning and end of the trend. This is often the case, but OBV analysis is unable to distinguish
between a genuine trend change and a pullback within the context of an existing trend. The
volume relationships from which the OBV is constructed are not designed by themselves to
identify genuine trend changes.
The third factor is that OBV tracks only the activity of those who are active in the market.
It is unable to distinguish between accumulation events and distribution events. Accumulation is
where investors begin to accumulate shares in anticipation of a trend change. Careful
accumulation will not always impact on the existing trend, or show a change in OBV as buyers
are buying on down days within a falling market.
The same applies to distribution where investors are selling stock because they believe
the uptrend has ended. Distribution is inadequately tracked using OBV measures because the
distribution sellers sell into a rising market to maximize profits. This bullish selling which is
distribution activity, does not reflect in changes in OBV values.
The OBV indicator is based on a largely untested assumption that volume increases at
the points at which a trend changes. This is either in anticipation of a downtrend change
buying or in anticipation of an uptrend change selling. Forget for the moment that this
assumption ignores one essential reality in the market. For every seller there must be a buyer.
For every person who believes the stock is going down, there is a buyer who buys the stock
because he believes it is going to go up, either now, or in the near future. In this very important
sense, bullish buying and selling is always balanced. Over an extended period the trend in
prices will tend to favor one outcome rather than another, so the balance is tipped in favour of
the bulls or bears.
We often extrapolate the momentum observation high volume and significant price
change and apply it to a longer term chart extract. The chart extract shows the logical
conclusion of this which suggests that trend changes can be confirmed by volume activity.

The volume chart above is taken from a chart that has five significant trend changes
from up trend to down trend, and from down trend to up trend. Your task is to use the volume
chart to identify the time points or areas at which you believe volume shows these changes in
trend. Next week we will give you the solution and explain why this type of activity is a
misleading distraction when we try to incorporate volume into better trend trading decisions.
And no, this is not a party trick. One of the most frequent questions I am asked in trading
seminars is What about volume? When we examine breakout trades identified using GMMA
analysis or CBL techniques the inevitable question comes What about volume? These
questions are all based on the assumption that volume is a useful way to confirm trend changes
or trending activity in price. This chart gives you an opportunity to see how the assumed
relationship between volume price and trending activity can be applied.
To understand the way in which volume is related to trending activity we must develop a
broader understanding of the information that volume give us. Volume is an indication of
participation in the market by existing shareholders or owners. Understanding their behaviour
provides a more useful tool in understanding the probability of trending behavior. We need to
move beyond the concepts of accumulation and distribution. We look at this in the next article.