Today we’re taking a break from option theory and diving headlong into technical analysis. I’m going to share with you how I think about the volume indicator. It’s super popular. After price (reading candlesticks, essentially), volume is the most commonly viewed metric. All charts display it by default. How many other indicators can say that?
If volume wants to brag, it has plenty of ammo.
The question I have is whether or not you’re using this ubiquitous indicator properly, if at all. Are you fully grasping the messages it broadcasts?
Pump up the Volume
My favorite way to introduce this
Price is the sentence; volume is the punctuation.
Read it again. And think. Let it simmer.
In grammar, punctuation adds emphasis. Mundane, ordinary sentences end with a period. Exciting, powerful, or urgent sentences end with an exclamation point.
Average volume
. = High volume = !
Most days in the market end with a period. The volume is average or low. Ordinary. It doesn’t mean much. But occasionally an exclamation point arrives. The volume is above average or high. That’s when you want to perk up. Take note. Whatever happened that day deserves more urgency. It carries more weight than days where the volume was average.
If you want to make it easier to spot the exclamation points versus periods, then see if your charting platform will overlay an average on top of the volume indicator. In ThinkorSwim, the “VolumeAvg” indicator does just that. Just so nothing is lost in translation, the bars that spike above the average line are above average.
Elephants of the Jungle
Market participants come in all shapes and sizes. Retail traders like you and me are the cockroaches of the jungle. We don’t have any weight to throw around. We add to the volume, yes, but only on the margins.
Institutions are elephants. Their movements are massive; their footsteps felt by all. As the stewards of billions, even trillions, of dollars, they are the volume.
Institutions = hedge funds, pension funds, endowment funds, mutual funds, and banks.
Imagine you’re a rookie on the trade desk of one of these elephants. Your boss directs you to invest $2 billion into a stock. You quickly smash the buy market button. Then your boss smashes your face and bellows, “ARE YOU INSANE?!! We don’t use markets orders. You just flooded the market with untold levels of demand. You’re going to push the stock price to the moon before we get our full order filled. DON’T YOU EVER USE A MARKET ORDER AGAIN!”
Institutions don’t buy, they accumulate. Buying is an event; accumulating is a process.
High volume up days are known as accumulation days. They suggest institutions are buying. And that is bullish because they may well continue to buy!
The same principle is applicable when the big boys want to exit a position. Elephants don’t sell. They distribute.
High volume down days
This is why high volume days are exclamation points. They signal the actions of big money. And big money is usually worth following.
