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Tuesday, August 17, 2010

Technical Analysis: Volume

Volume is an important aspect of technical analysis because it is used to confirm trends. Trading volume is the number of shares traded daily, on average. Any price movement up or down with relatively high volume is seen as a stronger, more relevant move than a similar move with weak volume. For example, that a stock jumps 5% in one trading day with high volume, usually goes up again the next day. If the volume is below average, there may not be enough conviction to support a trend reversal. Volume should move with the trend. For example, if the stock is in an uptrend but the up trading days are marked with lower volume, it is a sign that the trend is starting to lose its legs and may soon end.

Very low trading volumes signal lack of interest. The higher the volume, the more active the security. Low volume levels are characteristic of consolidation periods (prices move sideways). High volume levels are characteristic of market tops when there is a strong consensus that prices will move higher/lower. High volume levels are also very common at the beginning of new trends. Just before market bottoms, volume will often increase due to panic-driven selling.

Volume can help determine the health of an existing trend. A healthy up-trend should have higher volume on the upward price, and lower volume on the downward price. A healthy downtrend usually has higher volume on the downward price and lower volume on the upward price. Volume is closely monitored by technicians and chartists to form ideas on upcoming trend reversals. If volume is starting to decrease in an uptrend, it is usually a sign that the upward run is about to end.

Accumulation and distribution

Accumulation is when the market is controlled by buyers. A down-trend that stalls while volume remains high signals that accumulation is taking place. Sellers have lost control to buyers and a reversal is likely. An Accumulation occurs when volume increases and closing price moves higher, or when downwards trend there is little or no price movement and an increase in volume.

Distribution is when the market is controlled by sellers. An up-trend that stalls while volume remains high is a sign that distribution is taking place. Buyers have lost control to sellers and a reversal is likely. It happened when volume increases (compared to yesterday) and closing price moves lower, or after trending upwards, there is little or no price movement and an increase in volume.