It’s been awhile since I’ve thrown out some technical analysis goodness. Today we focus on the volume indicator. I bet you have it at the bottom of your beloved stock chart. Do you know why? Part of the answer lies in understanding the behavior of institutions, the big boys that drive markets up and down. Let’s focus on why we like high volume up days. Enjoy.

Suppose you run a large equity-centric fund targeting high growth companies.  The hold time for your positions range from multiple months to multiple quarters.  Given the gargantuan size of your fund, you swing a relatively big stick.  Anytime you enter or exit a market your actions have the ability to influences prices in the short-term.  Like an elephant stepping into a half-filled bathtub your entrance can cause noticeable waves and an overall rise in price levels. Of course, the ideal situation is to have no influence on market prices at all; to be able to slip in and out of positions when you want and at the price you want.

Let’s say you were looking to initiate a 10 million share position in a stock somewhat lacking in the liquidity department. Ideally you’d like to buy all 10 million shares at the current $20 share price.  Unfortunately, there aren’t 10 million shares currently offered at $20.  You have two choices.

A. If you value speed over price, then you might snatch up every available share for as long as necessary until you’ve established your entire position.  While such relentless buying may guarantee acquisition of your full position, it will have detrimental impact on the average price paid.  Like the aforementioned elephant stepping into the bathtub the size of your buying will undoubtedly lift prices.  By the time your buying frenzy is complete, you may have pushed prices north of $22, $23, or more. Of course, this lifts your cost basis to much higher than the original $20 you were looking to buy at.

B. If you value price over speed you may opt instead for the more stealthy route.  Rather than embarking on a buying binge and knowingly lifting prices, you could simply buy shares around the $20 level when they are available.  Like a predator lurking beneath the surface you wait for the water level to come to you.  Your bid at $20 remains in force until you’ve acquired your full position. Only this time, your cost basis comes out at the more desirable $20 level.

Of course, you may adopt some hybrid approach between these two examples where you occasionally bid prices higher when such an action makes strategic sense.  Unlike the individual investor who can buy or sell their position with ease, the big institutional players have to buy shares over time – a phenomenon often referred to as accumulation.

Stocks under institutional accumulation are often alluring buy candidates.  If multiple institutions are accumulating a particular stock, it’s as if multiple elephants keep stepping into the same bathtub lifting prices each and every time they look to snatch-up additional shares.

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