On the surface, this seems to make sense. When more investors become interested in a stock, they buy. The volume increases. Less interest means lower volume. Although this is true in some situations, it is not always evident. Whether or not this is true depends on several factors, including the current market strength and direction, as well as the strength and direction of an individual stock price.
To understand how volume may increase before prices increase, it is important to remember the existence of limit sell orders. Many times volume will suddenly increase; the price starts to increase and then falls slightly. Part of the reason for the decline is the presence of limit sell orders, or overhead supply. Another possible reason is nervous stock traders who buy on the volume increase but don’t see the quick price advance and so bail out.
Exxon Mobil
Exxon Mobil, a well-known oil company, has had the industry’s share of difficulties with low oil prices. Because it is a commodity, the supply of oil needs to be controlled in order to keep prices high. If too much is produced, the market becomes competitive and prices fall, which has a negative impact on prices.
Looking at the price and volume chart for Exxon in Figure 1, you can pinpoint occasions when increased volume precedes an increase in the share
price (the five arrows). The volume increase in June 2002 is especially pronounced.
ON-BALANCE VOLUME
Individual one-day spikes can also be significant signals, but notice that many of them are increased volume on a dropping price. Because of this, the signals can become confusing. Some investors counteract the confusion by using on-balance volume (OBV), by which they compare the volume to the price.
Developed by Joseph Granville, OBV can be a helpful indicator. It creates a volume line along the bottom of a price chart and is easily constructed. Start with a number that is relatively high, such as 50,000. On the first day, if the close is positive, that day’s volume is added to the 50,000 beginning number. If the day’s close ends lower, subtract the volume. On up days, add the volume, and on down days, subtract the volume. The result creates a fluctuating line.
On-balance volume can show an approaching trend change. The belief is that “smart money” sells a security when it’s near a top, and smart money
buys near a low. When the other investors catch on to a stock’s rise in price, volume will increase and the OBV line will increase rapidly and faster. On the other side, on-balance volume will start to decrease while the price is still rising, indicating that the smart money is leaving the stock.
The on-balance volume is also informative when it is decreasing while the price is increasing (diverging). A signal is generated that the rally may not be strong. When the price is declining and the OBV is increasing, the investor shouldn’t become too bearish, because a reversal could be coming.
General Motors
Take a look at Figure 2 to see General Motors with its volume. In spring of 2002, there was a clear divergence as volume started a distinct decline while the price was rising. The price peaked at $68.00 and headed down finally to reach support at $41.32 in May. The volume increased as the stock fell to $31.00 a share in October. The volume continued to increase and the price began to rise. It corrected again to $30.00 in 2003 and kept the volume strong. Buyers came on the scene as the price began a slow climb.
MARKET VOLUME
Volume as an indicator for individual stocks can be informative or misleading. However, volume as an indicator of the overall market can be significant. In general, the higher the volume, the greater the strength of the market move.
When there is a 100-point move on the Dow Industrial Average, the New York Stock Exchange volume will normally spike to a higher than normal level. But it’s not usually a spike that sends the signal; rather, it is a broader change. If the NYSE volume has been averaging 500 million shares a day but then steadily increases to 600 or 700 million shares a day, the market also moves. When the Dow Industrials move 100 points on the average or below the average volume, it is a sign of weakness. A market move on weaker volume indicates that many large investors are skeptical, which means that the likelihood of a reversal is high.
Take a look at the New York Stock Exchange volume chart in Figure 3 for January 1997 through December 1998. Although it’s interesting to see the weakness before the October 1997 correction (the Dow Industrials dropped more than 554 points), much of the rest of the volume indicates strength. Volume surges are unlikely when they are
already near record levels. There is a weakness during the last half of December 1997, but that is not unusual for December, when many traders are on vacation.
Volume in 1998 jumped above the 600 million share mark and stayed there during January. It’s interesting to note that this time period contains several record volume days for the New York Stock Exchange, as shown in Table 4-1.
The tallest single spike on the chart shows the day after (October 28)
the big correction in the Dow Industrial Average. October 19 had the sec-
ond largest volume, with the following day having the third largest vol-
ume for that period. These one-day volume records were accurate for the
time of the chart. The strength coming back to the market after the
October 1997 correction makes one wonder why the market corrected so
sharply.
CHANGES IN VOLUME
Always look for changes in volume for clues to strength. Short-term and
long-term changes both indicate strength, but the longer-term change is
normally the most meaningful. In the short term, if the market rallies on
weaker volume, the rally will not likely be sustained. If the market falls on
light volume, it usually turns up fairly soon. Over the longer term, if the
volume goes flat and then trends downward, it will often lead to a weak-
er market. The greatest strength is shown by an uptrend in the market
index (Dow Industrial Average or Standard & Poor’s 500 Index) and an
uptrend in the volume. When these diverge, it often signals a change in
direction.
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