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Greetings, fellow Pro-fundity team members -
1-7-00 Page
This Week's Guidepost
- As we try to understand what an increasing price trend means (or a downtrend) we
look for technical clues. Is the increase real, should we pour money into the security? Or
is it a random change without significance? Likewise, does the recent downtrend spell
disaster, should we sell and get out for what we can, or hang around for a recovery?
Good questions. The real question is "what is the market telling us about a particular
stock or the market in general?" When we learn what to listen for, as the market sends
its messages, we will increase the odds for our success.
- The difficulty in technical analysis lies in the quantity of indicators we can watch
and listen to. There are so many things to look for, where do we look first? The price
pattern itself is the most important message we ever will get. Following closely in second
place is volume, or the number of shares traded as the price pattern develops. Volume is
the focus of this Guidepost.
- To understand market forces that cause volume and price changes, we must know the impact
of institutional investors; Mutual Funds, Insurance Companies, Pension Funds, etc. The
reason is simply size. Up to 80% of the stock market volume is accounted for by these big
institutions. When these guys find a stock they like, they buy huge blocks of shares worth
hundreds of thousands or millions of dollars. However, they need to acquire those shares
slowly and patiently to avoid driving the price up before they reach their goal. The same
is true when they want to sell. Think what would happen to the price of XYZ if a fund put
in an order to sell 500,000 shares! They must dispose of their shares gradually to keep the
price up before they unload all their stock.
- With that under our belt, let's look at our first general rule for volume:
Volume will normally follow the price trend. Price and volume increasing together is
normal, with volume confirming the price. Price increases usually result from volume
increases. This means the volume increase normally comes first, that volume will lead the
price. Decreasing volume will have a like effect, leading ahead of a price decrease.
The price and volume chart below is for the ticker AGY, showing the price and volume
correlation from mid-October to the first week in the new year. The bars at the bottom
show the increased volume corresponding to the positive price spike in early December.
 D
Price/Volume Chart for AGY
We are careful to use the words "normally, likely, usually, probably" etc., in any
discussion of market action There will always be the exceptions, the case studies that fly
in the face of rule and logic. That does not diminish the value of the rules and
generalities. Rather, it helps us understand the principle of gains and losses. We will
always have both. Our goal is to increase the likely-hood of over-all larger gains and smaller
losses. That is why we are discussing volume in this Guidepost.
The next is a daily chart for ALDN, from April to the first week in January. In this
case, the volume bars are difficult to read relative to the price pattern. But we can see
the correlation between price and volume in early April, the middle of July, and the long
run-up starting in November. This confirms our first general rule about price following
volume.
Daily Price/Volume Chart for ALDN
This chart was used to demonstrate another tool for our use. We can change the
scale of our price chart from a daily to a weekly pattern. In the next figure, let's
take the same price pattern but change it to a weekly scale. In this case, each data point
on the chart is a weekly value (the close on Friday, the total volume for the week).
Notice how there is less noise in the volume bars and how much easier it is to see the
big picture. While it is important to watch price action each day, weekly charts get
you out of the trees to see some of the forest.
Weekly Price/Volume Chart for ALDN
This does make analysis a bit easier. Why don't we just show all Price/Volume charts
in a weekly format? The reason is fundamental! We want as many focal angles on a price chart
as possible. On most charting software programs, to go from a daily to a weekly format is
as difficult as a click of the mouse. We can go back and forth, increasing our understanding
of the big picture, as we do.
One of the biggest big-picture understandings a weekly chart provides is where the
institutional money is flowing. Remember, they are responsible for 80% of the volume.
We can sense institutional distribution (selling) and accumulation (buying) easier with
the weekly chart format.
Before we leave this introductory Guidepost on volume, let's look at a Price/Volume
chart of a recent pick, EQNX. This pattern illustrates an example of our second general
rule for volume:
When volume does not follow the price trend, an abnormal case exists.
This divergence broadcasts a powerful message we must listen to. When prices rise with
decreasing volume, the rally is weak and not likely to continue. Or, when price
falls in the face of increasing volume, look for a recovery. In other words, whenever
volume does not confirm the price action, a red flag should go up.
First the daily chart:
Daily Price/Volume Chart for EQNX
Now compare the weekly chart:
Weekly Price/Volume Chart for EQNX
As the price increased from mid-October through November, there was no confirmation
of this action with volume. The rally died without volume support. It has tried to rally
again as volume still does not provide confirmation. Where to you think the price is
headed next? Watch this price action in the coming weeks to see if the lessons stick.
We have just witnessed the use of a powerful technical analysis tool, Volume. There
are easier ways to utilize this tool which we will discuss in next weeks Guidepost. Before
next week, click on the Archives link on our home page and read carefully the Guidepost
dated May 28, 1999. This will give you a good review of the On Balance Volume (OBV)
indicator. We will discuss some applications next week. Stay tuned.
Understanding:
It is our intent to help our subscribers understand market strategies well enough to
make informed decisions and understand the risks.
We provide TC-2000 tutorials to members. See the Member Login page.
Be diligent...
Take action!
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