When volume is low, but gains and losses are big, the professionals tend to get overly excited about a possible turn in market direction. That's because many have been taught that without strong volume, a market move is not valid. Here we look at how to interpret volume and the principles behind doing so.

Tutorial: Stock Oscillators And Indicators

Simple but Powerful
Volume is the indicator at which chartists constantly look to determine whether or not a move in the markets, a sector or a single issue, has conviction. It may also be the easiest of all indicators to understand; add the number of shares traded in a given period and you have the answer. It requires no weightings or exotic mathematical formulas. It simply indicates enthusiasm or lack thereof for an issue and it has nothing to do with the price.

To confirm a market turnaround or trend reversal, the technical analyst must determine whether or not the measurements of price and volume momentum agree with each other. If they do not, it is a sure indicator of weakness in the trend, and thus a trend reversal may be well on the horizon. If we have a look at volume from the standpoint of momentum, we see a recognizable level of buying and selling activity. (For additional reading on volume, see Volume Rate of Change, Gauging Support And Resistance With Price By Volume and How To Read The Market's Psychological State.)

The Oscillator
A volume oscillator measures volume by measuring the relationship between two moving averages. The volume oscillator indicator calculates a fast and slow volume moving average. The difference between the two (fast volume moving average minus slow volume moving average) is then plotted as a histogram. The fast volume moving average is usually over a period of 14 days or weeks. The slow volume moving average is usually 28 days or weeks. On a regular basis, analysts argue over whether or not the lengths of these time periods are appropriate. Some say that 14 and 28 are too conservative, while others argue these numbers are not conservative enough.

Here we use use 5/20 like a short-term trader. The histogram, like an oscillator, fluctuates above and below a zero line. Volume can provide insight into the strength or weakness of a price trend. This indicator plots positive values above the zero line and negative values below the line. A positive value suggests there is enough market support to continue driving price activity in the direction of the current trend. A negative value suggests there is a lack of support, that prices may begin to become stagnant or reverse.

Interpretation
If a market is rallying, the volume oscillator should rise. When the issue becomes overbought, the oscillator will reverse its direction. If the market is declining or moving in a horizontal direction, the volume should contract. Always keep in mind that we are measuring changes in volume, and volume expands during a sell-off. It is important to note that an increasing price, together with declining volume, is always, without exception, bearish. When the market is at the top, one would therefore see an oversold volume chart. Another important fact is that rising volume, together with declining prices, is also bearish.

082702_chart1small.gif
Chart Created with Trade station

A look at the chart of the Dow Jones Industrial Average from Aug. 2001 to Aug. 2002 shows two significant run-ups in the volume oscillator, after equally significant slides. The first is a result of the activity after Sept. 11 and the subsequent market turnaround on Sept 21. The second is the result of fall-off during the summer and a turnaround of over 1,500 points, over the proceeding weeks.

For the first case, you can see that the volume increased dramatically when the market collapsed on the re-open of the exchanges on Sept. 17, 2001. The Dow then witnessed very low volumes with the rising market, after the bounce on Sept. 21. Volumes were low mostly because investors were still in shock; only the most steely-nerved investors got back in. The second case occurs in line with annual summer market conditions where, for the most part, the institutional players are gone for the month of August; furthermore, the pundits find little excitement, because of a lack of volume when the market moves daily 100 points in either direction.

The Bottom Line
This is only one of the many tricks that can help you gauge market direction, in order to further enhance your investments. When it comes down to it, no system is 100% reliable, so no matter how confident you are, remember, it's your money, invest it wisely. (For more on gauging market direction see 4 Ways To Predict Market Performance.)

Related Articles
  1. Charts & Patterns

    How To Use Volume To Improve Your Trading

    The basic guidelines to analyzing volume may not apply in all situations, but overall, they can help direct entry and exit decisions.
  2. Chart Advisor

    ChartAdvisor for February 5, 2016

    Weekly technical summary of the major U.S. indexes.
  3. Chart Advisor

    3 Charts That Suggest Now Is The Time To Invest In Real Estate (VNQ, SPG,PSA)

    Real estate assets have some of the strongest uptrends around. We'll take a look at three candidates poised for a move higher.
  4. Chart Advisor

    Stocks With More Upside Due to Bear Traps (TAP, SPY)

    A bear trap is a pattern that typically leads to at least a short-term rise in prices. Here are stocks exhibiting the pattern.
  5. Chart Advisor

    ChartAdvisor for January 29, 2016

    A weekly technical summary of the major U.S. indexes.
  6. Stock Analysis

    3 Risks U.S. Equities Face in 2016

    Find out why the probability of a U.S. stock bear market is increasing in 2016 and what the greatest risks are to the bull market that is almost 7 years old.
  7. Active Trading Fundamentals

    New Traders: Trade the Market in 5 Steps

    New traders shouldn’t throw money at securities without knowing why prices move. Follow these five steps to tilt the odds in your favor.
  8. Chart Advisor

    Watch For a Bounce in These Emerging Markets (BRF, PEK)

    While downtrends are clearly in control of the direction of many emerging market ETFs, short-term indicators suggest a bounce higher could be in the cards.
  9. Investing Basics

    Valuation Models: Apple’s Stock Analysis With CAPM

    The capital asset pricing model, or the CAPM, estimates the expected return of an asset based on the systematic risk of the asset’s return.
  10. Stock Analysis

    Will "FANG" Stocks Outperform in 2016?

    Facebook held the most bullish accumulation-distribution pattern into year’s end, telling investors to focus on this issue in 2016.
RELATED FAQS
  1. What are the most popular volume oscillators in technical analysis?

    The most popular volume oscillators in technical analysis are the Percentage Volume Oscillator, or PVO, and the Chaikin Oscillator. ... Read Full Answer >>
  2. How are Triple Bottom patterns interpreted by analysts and traders?

    The triple bottom is a relatively rare chart pattern with an exceptional degree of reliability, making it a favorite among ... Read Full Answer >>
  3. What are the best technical indicators to complement the Upside/Downside Ratio?

    As a volume and momentum oscillator, the upside/downside ratio has two broad roles: confirmation and divergence. One of the ... Read Full Answer >>
  4. How do I build a profitable trading strategy when spotting an Upside Gap Two Crows ...

    The primary factors in the creation of profitable trade strategy based on the upside gap two crows pattern are outside evidence ... Read Full Answer >>
  5. How effective is creating trade entries after spotting a Upside Gap Two Crows pattern?

    The reliability of the upside gap two crows reversal pattern is somewhat debatable. Each analyst and trader has his or her ... Read Full Answer >>
  6. What is a common strategy traders implement when using STARC Bands?

    Stoller Average Range Channels (or STARC), Bands were created by Manning Stoller in the 1980s to help generate trading signals ... Read Full Answer >>
  7. How are Saucer patterns interpreted by analysts and traders?

    Saucer patterns are U-shaped formations that indicate the market bottom for the underlying asset. Most analysts and traders ... Read Full Answer >>
  8. How do I build a profitable strategy when spotting a Symmetrical Triangle pattern?

    The symmetrical triangle chart pattern is generally considered a reliable continuation signal that lends itself easily to ... Read Full Answer >>
  9. How effective is creating trade entries after spotting a pennant pattern?

    Although chart patterns may lend clues to future price action, their reliability can vary widely. For traders and analysts, ... Read Full Answer >>
  10. What are the best technical indicators to complement a Moving Average Ribbon?

    Each of the moving averages inside of a moving average ribbon play a least a cursory complementary role for each other, smoothing ... Read Full Answer >>
  11. How are Multiple Tops patterns interpreted by analysts and traders?

    A multiple tops chart pattern occurs in an ongoing uptrend and indicates the trend is nearing exhaustion. If a security repeatedly ... Read Full Answer >>
  12. How effective is creating trade entries after spotting a Multiple Tops pattern?

    Despite the middling reliability of multiple tops, a shrewd investor can still create an effective trade strategy using these ... Read Full Answer >>
  13. Why is the Negative Volume Index (NVI) important for traders and analysts?

    The Negative Volume Index (NVI), along with its cousin the Positive Volume Index (PVI), is one of the oldest technical indicators ... Read Full Answer >>
  14. How do I build a profitable trading strategy when spotting an Multiple Tops pattern?

    Multiple tops patterns, of both the double and triple varieties, are relatively commonplace. However, because they are only ... Read Full Answer >>
  15. Why is the Detrended Price Oscillator (DPO) important for analysts and traders?

    The detrended price oscillator (DPO) is an ambitious indicator that aims to eliminate more powerful long-term trends in order ... Read Full Answer >>
  16. How are Exhaustion Gap patterns interpreted by analysts and traders?

    Exhaustion gaps are one of the four major gap patterns that appear in price charts (the others being common, breakaway and ... Read Full Answer >>
  17. How do traders identify confirmation of prices on a chart?

    Technical price confirmation comes in many different forms. The stock market is full of indicators, oscillators, patterns, ... Read Full Answer >>
  18. How do investors and traders use the Commodity Channel Index - CCI?

    The commodity channel index (CCI) is a technical momentum oscillator used by traders to spot overbought and oversold positions ... Read Full Answer >>
Hot Definitions
  1. Super Bowl Indicator

    An indicator based on the belief that a Super Bowl win for a team from the old AFL (AFC division) foretells a decline in ...
  2. Flight To Quality

    The action of investors moving their capital away from riskier investments to the safest possible investment vehicles. This ...
  3. Discouraged Worker

    A person who is eligible for employment and is able to work, but is currently unemployed and has not attempted to find employment ...
  4. Ponzimonium

    After Bernard Madoff's $65 billion Ponzi scheme was revealed, many new (smaller-scale) Ponzi schemers became exposed. Ponzimonium ...
  5. Quarterly Earnings Report

    A quarterly filing made by public companies to report their performance. Included in earnings reports are items such as net ...
Trading Center