Price Pays…Does Volume?

Derek Hernquist

The role of volume in analyzing markets is like the US political landscape...outspoken partisans on the fringes, but most falling in the "I wish it was reliable" camp.  I am part of the mushy middle.  Sometimes high volume is bullish, sometimes it's bearish. Sometimes low volume is a warning sign, sometimes it's not.  Rather than drop it because it's not perfect, however, I choose to use it as a clue when it matters and ignore it when it doesn't. 

As Brian Shannon says in his book, volume allows us to measure the emotional intensity level of the participants.  Market Profile proponents like Dr. Brett Steenbarger and Jim Dalton say volume on a breakout tells us whether value was accepted or rejected at new levels.  What's so helpful about these 3 great authors is the space they commit to explaining the details of the auction process, which is all markets really are...a search for true value.

Like any measure, context is key to unveiling clues.  To know if volume is worth our time we need to answer the following questions:

1) Is there a recent high or low we can analyze?

Why wait for highs and lows?  Because that's where we can expect the greatest emotional intensity.  Visualize a trading range as a football field between the 20's...the movement here gives little insight into the quality of the teams as full commitment is lacking.  Now move the battle inside the 10.  Participants gain focus and generate higher emotions as every inch is challenged.

2) Did that high or low follow an Uptrend, Range, or Downtrend?

Consider the current positioning of the players.  If the stock is trending, we simply want more of the same, right? Steady price movement, consistent volume and range...any changes mean the character of the activity is changing. Here's where I use volume to make sure I'm not getting suckered by a faulty high or low.  If a stock I'm watching makes a 5-10 day high but volume or range are tiny, I take it off my board as a candidate(or sell some if I'm long).  If it's been trending and now volume is off the charts on a high, we have an emotional situation in need of a breather and take some profits as well.

A range offers different dynamics, as much of the action is random.  Not until we see battles at the range extremes can we use volume as a measuring stick.  Once the victor emerges, however, we should see a few days of a totally new "normal" for volume as committed range traders reposition and new participants join the battle.  Given the dynamics of a trading range break, we have to be VERY suspicious of a break that occurs without volume.

3) Is the stock now trading above or below the price of the most recent battle?

Bring in VWAP as a measure of determining control, and consider it the goal line being battled over.  Observing the winner(+/- VWAP) in a period of high emotional intensity(volume) gives us great insight into who has control, and is most likely to win these battles throughout the game.  Call me a mercenary, but I'd rather be on the side that won the last time emotions were spent.

A trader friend of mine mocks volume, asking "Would you rather get hit by an empty freight train or a full one?".  Good point, which I why I follow trends rather than fight them...I don't want to get run over at all!  Volume clues would never cause me to enter a new position against trend.  Most of the time, volume ranks as irrelevant on my list of measures to consider.  However, if you take the time to think through what volume is telling you about the players, I believe you can make the case that knowing when it matters is more important than knowing if it matters.  For me, it is an invaluable tool in the constant pruning of positions and evaluation of new ideas.


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