Volume is not difficult to understand once the basic principles of supply and demand are understood. This requires you to relate the volume with price action. Volume is the powerhouse of the stock market. Start to understand volume and you will start to trade on facts (not on ‘news’). Your trading will become exciting as you start to realize that you can read the market – a very precious skill that only a few people share.
To say that the market will go up when there is more buying (demand) than selling – and go down when there is more selling (supply) than buying may seem like an obvious statement. However, to understand this statement you need to look at the principles involved. To understand what the volume is saying to you, you have to ask yourself again, “What has the price done on this volume”?
The price spread is the difference between the highest and lowest trading points reached during the timeframe you are looking at, which may be weekly, daily, hourly, or whatever other timeframe you choose.
Volume shows the activity of trading during a specific period. If the volume is taken in isolation it means very little – volume should be looked at in relative terms. Therefore, if you compare today's volume with volume during the previous thirty days (or bars) it is easy to see if today's volume is high, low or average compared to the volume seen in the past. If you stand thirty people in a line, it is easy for you to see who the tall ones are, compared to the others. This is a skill of human observation, so you will have no problems identifying whether the volume is relatively high, low or average.
Compare this volume information with the price spread and you will then know how bullish or bearish the professional wholesalers really are. The more practice you have, by taking this professional approach, the better you will become.
To make it easier for you to understand volume, compare it to the accelerator of your automobile. Think about the results you would expect from pressing the accelerator when approaching ‘resistance’, such as a hill. Imagine you are an engineer monitoring a car's performance by remote control. Your instruments only allow you to see the power applied to the accelerator pedal (volume) and a second engineer is looking at the cars actual motion (price movement). The second engineer informs you that the car is moving forward uphill; however, this uphill movement is not in keeping with your observation of power to the accelerator pedal, which you observe is very low. You would naturally be somewhat skeptical, as you know a car cannot go uphill without sufficient power being applied.
You may conclude that this movement uphill could not possibly be a genuine lasting movement, and that it is probably caused by some reason other than power application. You may even disbelieve what your instruments are telling you, as it is obvious that cars cannot travel uphill unless power is applied to the accelerator pedal. Now you are thinking more like a professional trader!
Many traders are mystified if the same thing happens in the stock market. Remember, any market, just like an automobile, has ‘momentum’ that will cause movement even when the power has been turned off. This example explains why markets can momentarily rise on a low volume up-move. However, all moves with differing types of volume activity can be explained using the “accelerator pedal” analogy.
Next : What is Bullish & Bearish Volume?
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