By Nigel Hawkes, President, Hawkeye Traders*

Many thousands of words have been written on volume over the years, but its secrets elude many traders. Until a trader has a full understanding and appreciation of volume, though, it is my considered opinion that he or she will be making judgments that do not take into account the basic “supply and demand” of the market.

Probably the greatest proponent of volume was Richard Wyckoff, who, in the early 20th century, read the ticker tapes using volume as his lead indicator. It is quite remarkable that, at that same time, two other great traders, Elliott and Gann, were also making their mark as great traders.

However, the markets have moved on from those early days of ticker tape and market manipulation, and, now, with computers and immediate accessibility to data, all traders can see exactly what is happening within a split second. It makes me wonder how those three great traders mentioned previously would have adapted their methodology in today's environment.

Gann was certainly squaring time and price. So, I feel that, now, he would be squaring price and volume. In today’s market, you need to see x amount of volume to fulfill a price move. Whereas, in Gann's time, you needed to see x amount of time to fulfill a price move.

As for Wyckoff: There are probably 40 independent Wyckoff profiles, so, for further study, I suggest you buy The Wyckoff Method, published by Stocks and Commodities magazine.

Now, let’s take a look at some key aspects of volume.

Major Upthrusts

Upthrusts are money-making traps to catch stops and are usually signs of weakness. If you have a distribution area directly behind you, it now becomes a very strong indication of weakness. And, if the volume is high, it adds more weight. A sharp move down the next day will confirm the weakness.

Why have upthrusts? In any market, you will have stop orders above the market. Because traders think the same things collectively, these stops will be in a fairly close price band. Then, the market makers, knowing where these stops are, hit them with little cost to themselves.

The same applies in reverse in down markets.

The Buying Climax

A buying climax marks the end of a bull market. It is shown by a rapid price rise. After a bull market, if the volume is always ultrahigh, and the spreads very wide and up, the news will be good. If you are into all-time, new-high ground, this will mark the tops. (Note that the volume must be ultra-high.)

Uniformed traders will abandon caution and buy the market because they believe that, otherwise, they will miss out on further rises. This gives the professional trader the opportunity to sell into the buying at very high prices without bringing the market down.

This stops the bull market. What is interesting is that the bull market cannot stop going up until major selling comes into the market on ultra-high volume on up days.

Accumulation

Professional money is buying stock. They cannot just go into the market and start buying. This will only put the price up against them, so they have to accumulate over a period of time, buying when bouts of selling come into the market.

Having bought in the morning, they may have to depress the price by selling enough of the stock quickly to bring the price back down. But, overall, they are buying more than they are selling.

Distribution

This means the selling of large lines of stock bought at lower prices from potentially weak holders. As a market rallies, a level will be reached at some point, at which, traders who have missed out on the up move or have sold prematurely cannot stand the constant rise so are liable to buy into the market.

Selling large lines of stock bought in the lower part of the trading range cannot be done overnight. The professional trader cannot just sell at will; he or she will have to distribute. Once the pro decides to start taking profits, he or she can only sell surges of buying.

Shake-Out

This is a widespread down that then reverses to close on the highs on high volume. A shake-out usually occurs as a result of bad news. This is a money-making maneuver to hit stops. Those long in the market are forced to cover.

Traders who were thinking bullish are now fearful to enter the market. Those who shorted the market will be forced to buy back later. However, the close on or near the highs shows that professional money is coming in and covering its short positions (buying) and absorbing the weak sellers.

Possible Test

Testing is a very frequent signal. It’s a good one for going long when you already have signs of strength in the background down during the day but closes on the highs on low volumes. It should be followed by an immediate up move.

Possible Failed Test

Supply is still present (down during the day to close on highs on low volume). It is usually a sign of strength. In this case, the volume is not low, showing that there is still selling (supply).

Rarely will a market go far with supply in the background. However, you can expect high volume testing. This shows the activity of professional traders taking positions for a move.

Effort to Rise Failed

This is seen in the market frequently if, for example, there is a wide spread up day on high volume while the next day reverses down on a wide spread, also on high volume. This is now a serious sign of weakness. A wide spread up on high volume shows effort to go up.

If the next day is down, this can only show that, within the high volume seen the day before, selling overcame the demand. Otherwise, prices could not possibly have fallen the next day. Caution is necessary, though; it is the second day down that is important. If that second day is down on low volume, this can show that the selling has stopped, and you can expect the market to go up.

The intraday volume action of a market conforms to a pattern when the market has a sizeable speculative following. The common volume pattern is heavier volume during the opening and closing minutes of trading with fairly uniform activity in between. This pattern offers scalping opportunities, as well as position trading and market trends.

Volume study on an intraday basis requires dedication, considerably more time and attention to the market than most traders can spare. However, being aware of high volume activity on opening and closing and the market’s wandering characteristics give the volume trader an advantage.

Heavy opening volume is reflective of the accumulation of overnight orders. If the market does open higher on pretty heavy volume, usually the market will settle back for a spell.

On the other hand, if it opens lower on pretty heavy volume, anticipate that prices will rise during the mid-morning session for a while. Putting aside the accumulation of news and overnight activity (because markets never sleep), we consider the action of the prices of the day before we consider the analysis of the volume of this action in anticipating the kind of opening that will occur.

1. Anticipating a higher opening.

The price action during the day would continue to rise right up to the close. It is strong, steady and aggressive. Prices might be under heavy accumulation at the lower part of the day’s range and, in the last hour, would take a run to close at or near the day’s high. You would certainly expect a higher opening the next day

The opposite is true for a lower opening.

2. Anticipating lower prices on opening after a rise in prices the day before.

After an update, with prices stalled and pretty heavy volume in the last half hour or so, supply catches up with demand. Prices trade up on heavy volume. They run into resistance during the closing hour of trading. Then, prices falter. Reckon on a lower opening the next day.

The reverse applies for a higher opening.

Types of Minor Reversals

Within the context of overall trend action, there are four categories of minor reversal points:

1. Overall up-trend reverts into counter down trend.
2. Counter down trend reverts back into overall up-trend.
3. Overall down trend reverts into counter up trend.
4. Counter up trend reverts back into overall down trend.

On balance, therefore, overall trend reversals into counter trends are signaled by low volume while counter-trend reversals back into the overall trend are signaled by volume increase.

That’s because buyers in an up market dominate and are, thereby, more aggressive in purchasing. Whereas, a market will decrease quickly when there is no buying volume until it finds fair = value and is then bought again.

Types of Market Reversals

There are two types of market reversals:

1. Minor
2. Major

The major reversal is the conversion of an overall up trend into an overall down trend (or visa versa) and is always a bottom or a top. The understanding of volume during major reversals is most crucial to trading success. Volume during major reversals forecasts two things.

1. The prevailing overall trend is nearing an end.
2. The next trend will be in the opposite direction.

Because the duration of tops is normally so much briefer than that of bottoms, it is easy to be trapped into the wrong side of the market. It takes far greater agility to go short a market at its top than to go long a market at its bottom.

Market tops are potentially more treacherous than market bottoms for quite another reason; human nature is more bullish than bearish.

After a market has enjoyed an extended price advance, there will be those who will be eager to get on the bandwagon. The result will be a normally high volume with ultra-wide price fluctuations. The new price level may linger for a while or even go higher on gradually diminishing volume.

The message that volume gives remains crystal clear. The trend is over, so abnormally high volume along with wide and ultra-wide bars after an extended price advance and small ranging days are your signal.

High volume with large and ultra-wide fluctuations is known as an upside volume blow-off. A downside volume blow-off is as common but not usually as pronounced. Because of the bullish inclination of human nature, down-side-volume blow-offs are frequently imagined long before they occur. Therefore, a series of minor moves will precede the violent down-side move that signals the end of the bear market.

You might be thoroughly confused by now. But, read this article over again. It's not really that bad!