The most effective way of using the Effective Volume tool is to look for accumulation by large players during a trading range. When I see such an accumulation taking place during a few consecutive days, I purchase shares. I then place a stop below that trading range and wait for the stock price to rise. If large players stop buying before the price rises, I review the situation.
Unfortunately, large players are not always right. They do not always act on privileged information or after running sophisticated analysis. However, if you have to buy a stock, you are certainly better off buying a stock that is experiencing strong accumulation by large players, especially if your traditional tools indicate that the time is right to buy.
Here is a good example with the company Federated Investors Inc. (FII). The weekly traditional analysis chart shows in Figure 1.17 that at point A the stock price is back to a one-year-old support level. Since it is hitting the line of support, the probability for a reversal is high. The Relative Strength Index (RSI) shows an oversold signal, indicating a possible cheap value compared to past prices.
The daily graph (Figure 1.18) shows that at point A we are in a trading range, but it is difficult to evaluate the best timing to purchase the stock: Is it better to buy at point A or at point B? Please note that during a trading range, both RSI and moving average convergence/divergence (MACD) are of little use.
The Effective Volume analysis clearly shows that during the trading range, one or more large players have been heavily accumulating (see Figure 1.19). You can see that the difference between the buying and the selling pressure by large players was greater than 1,000,000 shares during the last 20 trading days leading to point B, or 50,000 shares per day. Knowing that 800,000 shares on average are exchanged every day, the imbalance between buyers and sellers was 50,000/800,000 = 6.25%, which is by experience very important.
A good question would be: How do we know that we need to buy at point B instead of buying at point A?
The answer is: We do not know! There is no way to know when the large players will be satisfied with the accumulated shares, and when (if
ever) the price will move up (we may suppose that the price will move in the direction of the Effective Volume accumulation, which is often the case). My own rule of thumb is to buy during a trading range when the accumulation by large players is constantly above 5 percent of the daily volume for a minimum of three consecutive trading days.
Figure 1.20 shows an increase in price from point B, which was not triggered by any news. We may speculate that the large players decided that they had bought enough shares and that it was now time to push the price up, attracting new buyers. (Please note the dating convention used in the graphs: 07/10/06 means July 10, 2006. The same convention is used throughout the book.)
Another question that you may ask is "When do I need to sell?" This is a good question, but Effective Volume alone will not give a satisfactory answer. Indeed, finding a good selling point is much more difficult than finding a good entry.
You could sell for a few different reasons:
• Your target has been reached.
• Large players have stopped buying.
• The price has not moved for some time.
• The price has become expensive compared to the underlying value of the equity.
We will analyze the selling decision process in Chapters 5 and 6.
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