Suppose we held a popularity contest with charting purists manning the judging table. Among the contestants are volume, ATR, price action, bollinger bands, and a score of other technical indicators. Throughout the day of competition the bollinger bands flex their adaptive volatility muscles, the stochastic stealthily hides its tendency to whipsaw, and a host of other indicators attempt to mask their lagging, redundant nature.
Finally, the results are posted.
Not surprisingly price action is declared the winner. As the other losers sit sulking in the back of the room they are subjected to yet another egotistical rant from Mr. Undefeated, “I’m king! I pay! You all follow me! I’m a one stop shop for comprehensive analysis, baby!”
After price action gets booed off the stage from all the jealous indicator types, volume steps up to claim second place. Regardless of the location or diversity of contestants, price action and volume habitually take the top spots time and time again.
I’ve seen a fair amount of analysis on the recent oversold bounce with most focused (as they should be) on price action and volume. Allow me to throw my hat in the ring with my own observation on volume. The conventional wisdom is that volume should confirm the trend. In an uptrend it should expand on rallies and diminish on pullbacks. In a downtrend it should expand on downswings while diminishing on rallies. Some have noted last week’s bounce occurred on diminishing volume which is altogether true. However, I’m not sure that would be my reason for betting on its failure.
[Source: MachTrader]
Virtually 100% of the time volume crescendos toward the end of a free fall. With that as the backdrop it is very difficult indeed to see volume get much higher on a subsequent rally. Rather than treating the diminishing volume on the bounce back as a huge warning sign, I would view it simply as a return to normal. Were I to attribute the failure of the bounce to some catalyst, it wouldn’t be the “lower volume”, but rather the fact that we had so much potential supply looming overhead following a severe crash which breached multiple support levels.
I suggest avoiding overemphasizing the decrease in volume that accompanies most recovery bounces. It should be expected.
For related posts, readers can check out:
The Hierarchy of Charting
Of Silver, Princes, and Volume
A Forest of Tree Candles
{ 8 comments… read them below or add one }
What is your definition of price action, for this clueless fundamental investor who incorporates price momentum?
Hey David.
Analyzing the price or “price action” if you will, involves three things:
1. Trend
2. Momentum
3. Support & Resistance
Anytime I engage in technical analysis these are the first three things I identify on a chart. Since virtually all technical indicators are derived from price, I find most to be redundant. After all, if they simply reveal what I could have already inferred by analyzing the price action, why bother?
Hello Tyler,
Can you elaborate on these 3 things? What does momentum mean? How do you measure it? and how does support and resistance relate to the first 2 things? (I’m not into charting at all,so I know very little).
Thanks
I drafted a blog post set to run tomorrow that elaborates on trend and momentum. There are a number of websites which address charting in depth.
Stockcharts.com has good trainings on the basics of trend, support/resistance, etc… If you’re interested just use the following address:
http://stockcharts.com/school/doku.php?id=chart_school:chart_analysis
Thanks,
Before I get carried away with researching this I wanted to ask you is there subjective proof that technical analysis works? The way I understand price action (without researching it) is that it can reflect certain truths about the stock right now and one could therefore predict the future. But the prediction isn’t coming from the price action it’s coming from you. If my understanding is correct I have no problem with that. However, much of what I hear about technical analysis is that it can predict the future and that is difficult for me to accept. Why should the past have bearing on the future?
Yet another good question which is probably best addressed in a blog post. Look for my answer later this week.
As someone who runs a stat arb shop, I would suggest that as markets are dropping, relative price spreads are more likely to get out of whack and stat arb traders will trade on those spreads, thus increasing volume. The same is not true as markets rise. Price spreads are less likely to get out of whack as the market recovers.
We don’t arb ETs, but I would guess that as the retail crowd is dumping ETFs with reckless abandon, there is lots of trading being down by authorized participants to arb out discrepancies between ETF prices and the intrinsic values.
Thanks for the additional insight Jon. That could certainly add to the volume discrepancy.
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