Volume

Volume is the second dimension of technical analysis. It indicates the active interest in a stock at any given time. If charts represent a map of the territory you are planning to embark upon, then volume measures the depth of that territory. Just as it is impossible for elephants to tread in the jungle without leaving footprints, it is also hard for institutional accounts to enter or exit positions without leaving traces through volume.

Volume provides traders with clues. Significant levels of support and resistance are often marked by high volume. High volume represents intense emotional and monetary interest. This conviction in the form of volume creates memories for future reference points. For example, if a stock trades to its all-time high on heavy volume and then sells off, there will be winners and losers. The winners are the ones who sold a long position, or shorted close to the top. The losers are the ones who went long, covered their short, or didn't sell close to the top. If and when the stock rallies back up toward its all-time high, the losers will be waiting with a vengeance for another opportunity to sell. When significant volume reference points are retested, emotions resurface and the buyers or sellers come back, attempting to amend past actions.

Volume spikes are often the result of numerous buyers or sellers reacting to some significant piece of fundamental news. Volume tends to attract volume. Large holders of stocks do not want to miss the opportunity to scale around a position if the stock is in play and is trading actively. The largest institutions are usually active in their largest positions most of the time, either adding to them, scaling them back, selling them, or just day trading them for short-term profits. When stocks move on volume that is above the 20-day moving average, price action and chart patterns have increased validity.

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