Price and Volume Relationships

As we learned in Chapter 3 , using average daily volume—or Ord-Volume, as I call it—we can measure and compare the strength of one leg to another. This volume analysis also can be applied to swings to tell you if the market has the strength to pass through a previous swing or if it is likely to reverse. (To refresh, a swing is the point at which a stock, index, or other issue changes direction. A -eg is the distance between two swings.) Previous swing areas are important to watch for strength or weakness. The way to tell whether the market is likely to pass through a previous swing high or low is by volume analysis.

Stocks develop trading ranges because a particular issue does not have enough strength to get through its previous swing high or its previous swing low. As stated in Chapter 3, what it takes to get through a previous high or low is energy. Energy, as we defined it, is the amount of volume that is pushing the price up or down. Put another way, the energy of the stock is reflected in how high or low the volume is. Now, a lot of traders will say that a stock had "good volume" on a particular day; say, one million shares. What does that really mean? By itself it does not mean anything, and, in fact, statements like these miss the point of what the stock volume is really saying.

Volume is always analyzed by comparing; it can be to previous legs or swings. The idea of volume analysis is to look for increases or decreases compared to previous swings or legs to identify whether there is an increase or decrease in strength. Stocks need an "energy source" in order to be propelled forward. That energy is volume. When the energy runs out, it will reverse. A trader should identify and understand which way the energy is pushing, and watch areas where the energy starts to reverse. That way, a trader will be better able to profit.

Don't make the process of stock trading more complicated by introducing factors that have little or no effect on stock price. Information overload is a common downfall in stock analysis. Keep it simple. Volume alone will tell you which way the force is pushing the stock. If a news announcement on a stock is released, then the volume (buying or selling) will make the right interpretation for the announcement—whether bullish or bearish—because people in the know will push the stock in its true direction. Therefore, the true interpretation of the news announcement will show up in the volume analysis. Personally, that is why I have little regard for fundamental analysis, because you don't know what points about the company are exaggerated and what points (if negative) are minimized. However, the true interpretation will show up in the volume analysis.

By following the direction of the highest volume, a trader is actually following the "smart money." Smart money is well capitalized and, therefore, has the means to produce the most volume. And, smart money produces the most money by being correct in the market. Therefore, if you can follow the direction of the highest volume, you can follow the smart money. To me, that is all the fundamental analysis you need to know. In my seminars, I talk about stocks by their symbols only; I don't even focus on the name of the company. The reason is that when I'm trading a stock, the name doesn't matter to me. I only need to know the symbol so I can pull it up on my quote system and analyze its price and volume.

It does matter to me, however, what sector the stock is in, because— as stated in Chapter 2—the sector also has to be bullish in order for me to be trading a particular stock. Other than that, the price and volume of the stock tells me what I need to know if I want to own it. I don' t get bogged down with information such as where the company is located, the number of employees, and so on. This type of information, to me, does not have a bearing on stock direction. The only thing that generates profits in the market is to know stock direction. Volume analysis will help find stock direction.


The first rule of volume analysis at swings deals with a very important concept: percentage relationship. We do not focus on the amount of the volume, but rather the comparison—on a percentage basis—of the volume versus a previous swing high or low.

Here is the rule:

It is not the amount of the volume that is important at previous swing highs or lows, but rather the percentage relationship compared with the previous high or low. These volume percentage relationships will determine if the market will pass through or reverse at these previous highs or lows.

Let's go one step further: To get a buy signal, a test is needed of a previous swing low and the volume must shrink by 8 percent or more, and then close back above the previous low. This condition will trigger the buy signal. A test means breaking the previous swing low to prove the point.

To get a sell signal, a test is needed of a previous swing high and the volume must shrink by 8 percent or more, and then close back below the previous high. This condition will trigger the sell signal. A test means breaking the previous swing high to prove the point.

These volume percentage relationships work on all time frames: 60 minutes, daily, weekly, or monthly. I might add that the higher the percentage decrease in volume on the retest of a previous high or low, the more reliable and stronger the signal will be for a reversal. That makes sense because if the energy is significantly less than at the previous high, there will also be less force, which means a safer trade for a reversal.

Let 's take a look at an example. Figure 4.1 shows a line chart of the hypothetical stock "ABC." I call this trade setup "low volume retest."

There is only one safe place to take trades and that is at or near a previous high or low. Think of the examples in Chapter 3 in which Ord-Volume buy and sell signal setups were taken on trades on a close above a previous low or below a previous high. In theory, if a market can'- hold below a previous low, then it is bullish. Similarly, if a market can't hold above a previous high, then it is bearish. Charts of the market are not randomly formed but are structured by tests of previous highs and lows, with the

Low Volume Retest Trade Setup for Stock "ABC"


Low Volume Retest Trade Setup for Stock "ABC"

market going in the direction of the highest energy. If a market runs into a previous high that has more volume than the current rally, then that high will be rejected, and vice versa.

Notice that I am giving volume equal status with price. Both volume and price must meet certain requirements to trigger a buy or sell signal. Now you have double confirmation for a signal to be triggered, and that is with price and volume. To illustrate, Figure 4.2 shows a sell signal triggered by this method on a weekly chart of Research in Motion Ltd. (RIMM).

Similarly, Figure 4.3 illustrates a buy signal triggered for RIMM, also using a weekly chart. Figure 4.3 also shows a sell signal triggered a few months later, also by the retest method.

Once a sell signal is triggered, the next downside target is the previous low. Therefore, a trader also knows what price is likely to become the next possible reversal point in the market. If the next swing low is tested

FIGURE 4.2 Sell Signal Triggered for Research in Motion (RIMM) with Retest of Previous High and Decline in Volume Source: Chart courtesy of

FIGURE 4.3 Buy Signal Triggered for Research in Motion (RIMM) with Retest of Previous Low and Decline in Volume, Followed by a Sell Signal Triggered by the Retest Method

Source: Chart courtesy of

FIGURE 4.3 Buy Signal Triggered for Research in Motion (RIMM) with Retest of Previous Low and Decline in Volume, Followed by a Sell Signal Triggered by the Retest Method

Source: Chart courtesy of

on equal or higher volume, then the downtrend remains intact, and the trader has reason to hold a short position. For a buy signal, the upside target is the previous high. If that high is tested on equal or higher volume, then energy is continuing to push higher, and the trader has a reason to hold a long position.

If you think these conditions through, you will see that what you are actually doing is following the way that the energy is pushing the strongest. Also remember that, whatever stock you are trading, you should be aligned with the overall direction of the market—and you should be in one of the best sectors (see Chapter 2). This alignment is like "putting the wind at your back," and it is very important to remember this factor. Being aligned with the market and the best sectors—to switch metaphors for a moment—will put "the wind in your sails," and will likely carry your positions farther and faster than you would otherwise experience.

This concept of keeping the "wind at your back" will be repeated in upcoming chapters. It's worth repeating because this is one of the main mistakes that traders make. Traders must always know what the broader market—as represented by the S&P 500, Nasdaq, and NYSE—is doing. Being aligned to the market and being in the best sectors will increase your chances of trading successfully "with the wind at your back."

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