Volume Analysis on stocks: The secondary indicator

Gautam Upadhyaya

02 Aug 2017

Volume is the one of the most important parameters used in technical analysis. Volume provides information of how many shares changed hands and at what price in a stock over a given time frame, giving an indication of interest in the stock.

Since each stock is different, and has a different number of outstanding shares, volume should always be compared to the historical volume of the stock in consideration to spot changes in volume trend. Volume is also used to confirm price trends, breakouts, and spot potential reversals.

Using Volume to Analyze Stock Price Movements

Simultaneously monitoring volume can aid in analyzing stock price movements. There are three primary ways volume is made use of in conjunction with price analysis: confirming trends, spotting potential price reversals, and confirming price breakouts.

Confirming Trends

Increasing volume shows conviction of buyers and sellers in either pushing the price up or down respectively. For example, if the trend is up and volume increases as the price moves higher, it shows buying interest and this is typically associated with larger moves to the upside going forward.

In the above chart, State Bank of India represents the above mentioned analysis as the volume gradually increases as the price surges higher. If you have taken a bullish position, the rising volume helps to confirm the uptrend. If you are short, the rising volume on the price rise tells you the price could continue to trend higher and it may be time to exit your short position.

A trend can persist on declining volume for long periods of time, but typically declining volume with rise in prices indicates that the trend is weakening. For example, if the trend is up but the volumes are steadily declining, it shows that there are only few traders who are driving the stock leading to a rise in price without broader participation. Any larger selling pressure could lead to a reversal in the uptrend leading to a sharp correction in the stock.

Volume should ideally be larger when the price is moving in the trending direction, and lower when moving against the trend (pullbacks). This shows the movement in the trend direction is strong and the pullbacks are weak, making the trend more likely to continue.

Spotting Price Reversal

For a trader to spot price reversal, identifying exhaustion move is important. Exhaustion move can be defined as a scenario wherein a particular stock moves higher with lower volumes and reaches its peak of its extended rally with maximum volumes i.e. 5x-10x of its average daily volume. This could possibly indicate the end of current trend.

Example 1: In the chart above of Repco Home Finance, we can observe a classic example of an exhaustion move, price hits an all time high with a huge spike in volumes, buyers get exhausted and with few buyers left to push the price higher, we see a reversal in the trend of the stock in the following days. 

Example 2: In the chart below of Bharat Petroleum, we witness a sharp decline in price along with a significant rise in volumes as the stock price hits its multi week low, indicating an exhaustion of sellers as majority of the ones who wanted to exit have exited this stock. And with few sellers left to push the prices downwards, buyers took the upper hand leading to recovery in prices.

Confirming price breakouts

In a scenario, a particular stock has a strong support or resistance levels, volumes can help to confirm a breakout. If the price has struggled to get above a certain resistance point, a conviction of buyers can be witnessed if the breakout is supported with larger volumes. Such breakout is likely to be legitimate.

In the above example of CESC Ltd, we witness a breakout from the sideways consolidation pattern on the daily chart backed by a steep surge in volumes. As the volumes increased with price breaching above resistance level, a possible bullish breakout can be expected.

A break above resistance, or below support, on lower volumes shows little conviction of the trade leading to the failure of the breakout. A common problem in technical analysis is buying an upside breakout, or selling a downside breakout, when volume doesn’t confirm it.

The chart above of Titan represents a false breakout. Assume that you had bought near the top of this range at Rs 542 expecting the price to move to Rs 560 levels, which is the target derived from a rectangle chart pattern breakout with a stop loss of Rs 525. In such a case, your bullish trade would have resulted into a huge loss as the stop loss price of Rs 525 got triggered since the breakout was not backed by strong volumes which provided a false signal, leading to a drop in price.

Confirming price pattern breakout

Price pattern breakout is similar to price breakout depending on volumes for confirmation.

In the above example of Ashok Leyland, we witness a cup and handle breakout backed by a rise in volumes which give an added confirmation to the trader. The stock has managed to hit its target price of Rs 110 which is derived from the cup and handle formation.  

Have Referral Code?

Similar articles

  • Responses
  • Patidar Samaj

    - 2 hrs ago

    This article claims RJio was given a "Backdoor Entry" into the 4G Based Voice Routing. The peculiar aspect is without the Voice License, Rjio would have been a mere ISP. With the license, it is now a holistic communications service provider, with ability to exponentially scale the bouquet of products. The events indicate it was meticulously planned way before the auctions because the auctions were clear on the agenda: 4G for internet only.

Load More
mutual-fund

Why to Choose Mutual Funds Instead of Directly Investing Into Equities?

Whether to invest in equities or mutual funds is a question that has plagued every investor. As someone who needs the best value for his/her investment should you invest in equity directly or via mutual funds?

Let’s start by first understanding what these two terms ‘equities’ and ‘mutual funds’ stand for-

Equities- Equities generally represent ownership of a company. If you own any equity in a company, you are a part owner of the said company (depending on how much equity you own).

Mutual Funds – It is an investment scheme which is professionally managed by an asset management company. It pools together the resources of a group of people and invests their money in equities, debentures, bonds and other securities.

Why choose mutual funds over equities?

For people who’ve never invested in either stocks or mutual funds, it is hard to know which is better and where to start. Broadly speaking, if you are a novice investor, mutual funds are not only less risky but also way easier to manage. Here are some ways in which investing in mutual funds is beneficial as opposed to investing in equities -

Diversification

Mutual funds provide more diversification as compared to an individual equity stock. When you invest in equity, you are investing in a single company which has its inherent risk. For example, if you invest Rs.20,000 in buying equities of one company, you could face a total loss if that particular company performs poorly in the market.  

If you invest the same amount in mutual funds, it will be invested in different kinds of stocks and financial instruments, high-risk and low-risk both, so you might not face total loss even if one company does poorly.

Scale of Investment and Lower Costs

For an individual investor buying and selling stocks is a difficult task due to its high price. Thus, any gains made from stock appreciation are nullified if the overall trading costs are considered. Comparatively with mutual funds, as the money is pooled from a large number of investors, the cost per individual is lowered.  

Another advantage of mutual funds is that you don’t need to invest large sums of money. Buying equities for a profitable venture needs huge amounts of money, a minimum of few lakhs. With mutual funds, you can start with Rs.1000 and earn profits on that as well.

Convenience

Keeping an eye on the markets everyday is a time-consuming business, especially if you are investing as a side gig. There are people who spend their lives studying the market and still end up sustaining heavy losses. Though investing in mutual funds does not guarantee high returns, it is stress-free and needs less work as compared to investing in equities.

To sum it up

It is important to remember that mutual funds have their own disadvantages as well. Thus, as with any financial decision, educating yourself and understanding the suitability of all the available options is the ideal way to invest. 


Banner

Volume Analysis on stocks: The secondary indicator

Gautam Upadhyaya

02 Aug 2017

Volume is the one of the most important parameters used in technical analysis. Volume provides information of how many shares changed hands and at what price in a stock over a given time frame, giving an indication of interest in the stock.

Since each stock is different, and has a different number of outstanding shares, volume should always be compared to the historical volume of the stock in consideration to spot changes in volume trend. Volume is also used to confirm price trends, breakouts, and spot potential reversals.

Using Volume to Analyze Stock Price Movements

Simultaneously monitoring volume can aid in analyzing stock price movements. There are three primary ways volume is made use of in conjunction with price analysis: confirming trends, spotting potential price reversals, and confirming price breakouts.

Confirming Trends

Increasing volume shows conviction of buyers and sellers in either pushing the price up or down respectively. For example, if the trend is up and volume increases as the price moves higher, it shows buying interest and this is typically associated with larger moves to the upside going forward.

In the above chart, State Bank of India represents the above mentioned analysis as the volume gradually increases as the price surges higher. If you have taken a bullish position, the rising volume helps to confirm the uptrend. If you are short, the rising volume on the price rise tells you the price could continue to trend higher and it may be time to exit your short position.

A trend can persist on declining volume for long periods of time, but typically declining volume with rise in prices indicates that the trend is weakening. For example, if the trend is up but the volumes are steadily declining, it shows that there are only few traders who are driving the stock leading to a rise in price without broader participation. Any larger selling pressure could lead to a reversal in the uptrend leading to a sharp correction in the stock.

Volume should ideally be larger when the price is moving in the trending direction, and lower when moving against the trend (pullbacks). This shows the movement in the trend direction is strong and the pullbacks are weak, making the trend more likely to continue.

Spotting Price Reversal

For a trader to spot price reversal, identifying exhaustion move is important. Exhaustion move can be defined as a scenario wherein a particular stock moves higher with lower volumes and reaches its peak of its extended rally with maximum volumes i.e. 5x-10x of its average daily volume. This could possibly indicate the end of current trend.

Example 1: In the chart above of Repco Home Finance, we can observe a classic example of an exhaustion move, price hits an all time high with a huge spike in volumes, buyers get exhausted and with few buyers left to push the price higher, we see a reversal in the trend of the stock in the following days. 

Example 2: In the chart below of Bharat Petroleum, we witness a sharp decline in price along with a significant rise in volumes as the stock price hits its multi week low, indicating an exhaustion of sellers as majority of the ones who wanted to exit have exited this stock. And with few sellers left to push the prices downwards, buyers took the upper hand leading to recovery in prices.

Confirming price breakouts

In a scenario, a particular stock has a strong support or resistance levels, volumes can help to confirm a breakout. If the price has struggled to get above a certain resistance point, a conviction of buyers can be witnessed if the breakout is supported with larger volumes. Such breakout is likely to be legitimate.

In the above example of CESC Ltd, we witness a breakout from the sideways consolidation pattern on the daily chart backed by a steep surge in volumes. As the volumes increased with price breaching above resistance level, a possible bullish breakout can be expected.

A break above resistance, or below support, on lower volumes shows little conviction of the trade leading to the failure of the breakout. A common problem in technical analysis is buying an upside breakout, or selling a downside breakout, when volume doesn’t confirm it.

The chart above of Titan represents a false breakout. Assume that you had bought near the top of this range at Rs 542 expecting the price to move to Rs 560 levels, which is the target derived from a rectangle chart pattern breakout with a stop loss of Rs 525. In such a case, your bullish trade would have resulted into a huge loss as the stop loss price of Rs 525 got triggered since the breakout was not backed by strong volumes which provided a false signal, leading to a drop in price.

Confirming price pattern breakout

Price pattern breakout is similar to price breakout depending on volumes for confirmation.

In the above example of Ashok Leyland, we witness a cup and handle breakout backed by a rise in volumes which give an added confirmation to the trader. The stock has managed to hit its target price of Rs 110 which is derived from the cup and handle formation.  

Have Referral Code?