are much harder to interpret than price patterns. The difficulty
stems from the clandestine strategies of big market players. These
folks tend to move slowly and cover their tracks within the broad
noise of daily movement.
While price bars tell many tales in a vacuum, volume has little
or no meaning without underlying price movement. But don't abandon
your volume study just yet. It still adds power to prediction
when you apply it judiciously.
The importance of volume depends on its location within the
overall pattern. For example, heavy volume through a broken
trend line suggests the start of a new trend, while the same
activity after a long rally or decline predicts a reversal.
This counterintuitive logic confuses traders and inhibits their
ability to decipher volume at key turning points.
Here are five volume patterns that show considerable predictive
power when interpreted correctly. Watch for these setups whenever
you're flipping through your charts. Then realize how volume
can yield vital information long before price action tells the
Stocks often go dead
for long periods after vertical rallies. The trick is to be
prepared when they start to wake up. Petroleum Development
rallied over 500% in a bull market run that gave way to a long
sideways market last March. Then volume begins to spike at two-
to four-week intervals after the stock prints a May double bottom.
a congestion pattern after a discernible low often signals renewed
buying interest that precedes a breakout. Notice how Petroleum
Development's buying cycle finally lifts price into a test of
the 52-week high in the low $30s. The stock pauses above resistance
for two weeks after the breakout and explodes into a fresh uptrend.
Shock Spirals --
Tony Plummer examines
the shock spiral in his classic book The Psychology of Technical
Analysis. In this text he shows how unexpected events can
trigger rapid price movement that takes on a spiral quality.
Multimedia Games' (NasdaqNM:MGAM) downward spike last summer
certainly qualifies as a shock spiral event.
The trick with this
phenomenon is to look for an A-B-C pattern in which A and C
move in the same direction as the shock, while B moves against
it. Additionally, the A and C waves often stretch to the same
length, creating a "measured move" scenario. This translates
into a substantial decline toward single digits for the casino
Shock Spirals --
Shock spirals can
occur in either direction. MedImmune (NasdaqNM:MEDI)
triggered a huge volume spike when Chiron (NasdaqNM:CHIR) had to pull its competing
flu drug off the market. Notice how the spike pushes the stock
above strong resistance. This could set up an A-B-C rally, with
the C wave breaking above the May high and sending price toward
Is there any real
difference between this pattern and a typical breakout pattern?
Absolutely. The huge increase in participation across the former
resistance level suggests price won't trade under the spike
bar low for months or years to come. Routine breakouts carry
a much higher failure rate.
Climax events are
counterintuitive because they signal the end of a trend just
when the crowd piles into a stock. Notice how Cree (NasdaqNM:CREE)
moves higher in two slow but steady rallies. The pace then quickens
while volume starts to increase. Finally, price goes vertical
for a few sessions, with volume peaking at a new high.
But both rallies
run out of steam immediately because the stock has run out of
buyers. This lets gravity kick in and trigger substantial declines.
Watch out for the classic signs of a trend blowoff when you're
trading vertical rallies or selloffs. Climax markets can turn
you from a shareholder into a bagholder very quickly.
On Balance Volume
XM Satellite Radio
(NasdaqNM:XMSR) shows all the signs of
a breakout above $32, except for one thing: The on balance volume,
or OBV, pattern is very weak. This bearish divergence sends
a strong signal to stand aside and let others take the risk
of a false breakout. It also suggests that a good short sale
could present itself, if and when the pattern rolls over and
starts to break down.
OBV is a great analytical
tool, but use it sparingly. It's most effective when price is
approaching important tests of old highs or lows. But it's best
to ignore the indicator while markets are grinding through the
debris of old congestion patterns. Accumulation-distribution
data are much harder to decipher when markets are going nowhere.