The best trading strategy in the world will never work, if you allow your emotions to overrule your logic. — Thom Goolsby
Price action gives us a clear picture of what has and is currently occurring regarding the value of a stock/ETF.
Volume analysis helps us see why price has been changing. Plus, it gives us insight into the stability of price action and where it may be going in the future.
Commonsense would dictate volume and price move in sync with volume size reasonably reflecting price movement and vice versa.
Think of supply and demand. When more people desire to own a stock/ETF, we would expect volume and price to be reflective of each other: increasing price goes together with higher volume and decreasing price goes together with lower volume.
However, this matching movement between price and volume is not always the case. Why? Now, hold onto your seat…. The markets are subject to manipulation! That’s right. Large institutions, dark pools, market makers and various insiders are many times at work, self-dealing and manipulating prices to their advantage.
1. Small Price Move, High Volume
Many times, volume action, when viewed in conjunction with price movement, can give you an idea as to what they are doing. If large price movement is occurring, but volume action is not reflecting such movement, several possibilities exist:
A. Distribution/Accumulation is occurring
B. Lack of buying selling pressure
C. Indecision in the marketplace
A. Distribution/Accumulation: When price and volume have been moving up with green candles, top wicks and matching volume levels, and then the candles change to spinning tops or dojis and high volume, this incongruity between price change and volume (low price change/high volume), can indicate a large amount of selling activity (distribution) by large traders or insiders. Such action is sending a significant bearish signal that the end of an up move is near.
Conversely, if price has been moving down with red candles, bottom wicks, and matching volume levels, and then the candles change to spinning tops or dojis and high volume, this incongruity between price change and volume (low price change/high volume) can indicate a large amount of buying activity (accumulation) by large traders or insiders. Such action may be sending a significant bullish signal that the end of a down move is near.
B. Lack of buying/selling pressure: When you observe high trading volume with minimum price change (small candle size) in a market that has been moving up or down, you maybe observing insufficient pressure to move price. This lack of pressure could be revealing insiders and/or market makers at work, trying to test the market’s willingness to accept a price increase/drop and finding no acceptance. Be careful and look for a breakout or a breakdown in price.
C. Indecision: High volume with minimal price change can be indicative of indecision in the market. This means buyers and sellers are equal and there is no clear direction for future price movement.
2. Large Price Move, Low Volume
Low volume levels and large price movements are signs of possible illiquidity, but more often, this discrepancy reflects actions by market makers and insiders. These parties are engaged in price discovery, i.e. they are manipulating price up or down to see if the current trend has exhausted all buying (in an up market) or selling (in a down market).
If you observe a large top wick (significant price move up) above a previous high, with little volume and no follow through in the next candles, it means the market makers and insiders have tried and failed to move price up and the trend may be exhausted or close to exhaustion.
The opposite as possible in a down market. If you see a large down wick, below previous low and little volume, with no price follow through in the next candles, the down move may be exhausted or close to exhaustion.
3. Bottomline: If Price and Volume Do Not Match, Investigate!
The bottomline with volume is that it should be expected to generally match price. This statement means that a large candle should have high volume. Accordingly, a small candle should have lower volume.
We always use a 20 period moving average setting on our charts to help judge volume size. Additionally, you can compare any candle and its volume to other candles and their volumes around it. Such comparisons will allow you to obtain a feel for reasonable price movement and volume size.
When volume does not correspond to price, something is amiss. As you spend time, practice trading, you will gain more and more prowess when reading price and volume fluctuations with all charts, in general, and your favorite and most often traded charts, in particular.