Advanced Price & Volume Analysis
One investing publication that strongly encourages the use of advanced Price & Volume analysis is Investors Business Daily (or IBD as I refer to them quite often). You can click here to be taken to their website. Since IBD articles mostly illustrate weekly stock charts, its outlook tends to provide more of a medium or longer-term outlook for stocks. That is the same outlook that I tend to focus on as well.
Investors Business Daily, founded by William J. O’Neil, takes their advance price & volume analysis and applies it to different base patterns. Their basic strategy includes buying a stock that is breaking out of a well developed base pattern (chart pattern). They recommend purchasing shares on a breakout only if the share price and volume action is considered favorable.
There are plenty of other philosophies and sound strategies that William J. O’Neil discusses in his book – The Successful Investor. I have developed a few of my own philosophies using his book as a resource so I definitely recommend the read. One of the volume strategies that I have developed myself is the “3 Volume Spike” theory. My 3 Volume Spike theory combines volume and Elliott wave patterns. You can read more about the theory on the links below.
I personally consider Price & Volume to be the 2 most important technical indicators when used together. When these 2 indicators are combined with other methods of technical analysis, they become even more powerful predictors.
Sure your stock’s share price went up today – but if you do not look at “how” the share price went up, you are only seeing half of the picture.
- Did the share price rise and the buying volume also increase when compared to the preceding candlestick?
- That typically indicates increasing buying demand and further increases in the stock’s share price is likely
- That typically indicates increasing buying demand and further increases in the stock’s share price is likely
- If the share price climbs while buying volume decreases, then the share price may be at or near a temporary topping area and ready for a period of consolidation
- Keep an eye out for a bearish reversal candlestick if you notice a stock’s share price advancing and buying volume keeps decreasing over the same time period
- Keep an eye out for a bearish reversal candlestick if you notice a stock’s share price advancing and buying volume keeps decreasing over the same time period
- When a stock’s share price falls but the selling volume decreases, that price action indicates that the bottom of the downtrend or consolidation period is near or happening
- Begin by analyzing other indicators to try and find additional support for a possible changing trend
- A bullish reversal candlestick is one such indicator
- A bullish reversal candlestick is one such indicator
- Begin by analyzing other indicators to try and find additional support for a possible changing trend
- If the share price falls and the selling volume increases over the same time period, the downtrend is gaining momentum and rapid decreases in the stock’s share price are most likely ahead
- This sort of price action normally develops in the middle of an extended downtrend and also in the final stages of a downtrend
- This sort of price action normally develops in the middle of an extended downtrend and also in the final stages of a downtrend
In general, you want to see increasing buying volume as the share price rises. This helps to confirm that there is growing demand for the stock.
But be wary of too much buying volume. Too much buying volume that comes too aggressively can produce a Climax Top. A Climax Top is when a stock’s share price advances dramatically in a short period of time. This rapid price movement produces an unsustainable pace for the share price, leading to a dramatic change from an uptrend to a harsh downtrend.
Price & Volume Requirements
When analyzing potential stocks to trade and purchase for investment purposes, I try to look for a minimum of $10 million traded in a single day. For example, a stock that trades approximately 500,000 shares as its daily average would need to be priced around the $20 mark ($20 X 500,000 = $10,000,000). If a stock does not trade in total value of $10 million as calculated, there could be an issue of liquidity.
One example when there is not enough liquidity for a stock – the bids usually dry up quickly as share prices tumble. Ever hear the expression that “stocks take the stairways up and the elevator down”? Sticking above the $10 million threshold helps to provide at least some liquidity just in case the elevator starts going down.
Support Areas – Small or Large?
Contrary to what most traders think, support areas with smaller price ranges tend to offer better trading opportunities than support areas with larger price ranges. Why is this? Smaller price ranges make the support area easier to define. When the price range is too large, support can be found anywhere in that large price range. In a smaller price range, there is less opportunity for support to be found at different levels within the support range because the price range is narrower. This makes identification of the support area much easier.
Trading Tips
Learning to apply as many of the trading tips as possible will help your investing success. Following are some of my tips and trading techniques when applying Price & Volume analysis.
Scale-In, Scale-Out
No one is smart enough to purchase at the bottom all the time. Therefore, it is best to use a scale-in strategy when looking to purchase shares of stock. A typical scale-in strategy would be 25-50-25, meaning 25% of the money you want to allocate to stock XYZ Corporation will be used for purchase #1. Then, 50% of the money for XYZ will be used for the next purchase, purchase #2. The remaining 25% is then used for the final purchase of shares for XYZ Corp.
When scaling out of a position, the strategy would be the same at 25-50-25; 25% of the shares should be sold in the first sale, 50% of the shares are sold in the second sale and the remaining 25% of shares are sold in the final sale.
Utilize a Core Position
When a stock’s share price is in an uptrend, consider trading around a “core position”. A core position ensures that you are never totally out of a stock that is trending upwards. Therefore, if you get caught out of position after a quick sale and the share price starts rising again before you have a chance to repurchase those shares, at least you still have some shares remaining in your core position.
I tend to keep around 50% of my shares as a core position, meaning I try to trade around the other 50% on rises and pullbacks.
Purchase The First Gap-Up
If you are watching a stock patiently waiting for an entry point and the stock develops a Rising Window Candlestick Pattern (gap-up), and this is the first gap-up that has developed during the current uptrend, the gap-up can be purchased using a scale-in strategy. Keep in mind that this automatic purchase only applies to the first gap-up in a new uptrend.
Cut Losses Quickly
This is also one of my “Investing Rules”, a rule that even I have a hard time obeying. But preserving capital while taking calculated risks is one of the fastest ways to build a portfolio’s value. Cutting losses at no more than 7%-8% is mandatory for all good investors and traders alike.
One of the secrets to winning big in the stock market is to not be right all the time but to lose the least amount possible when you are wrong. Some investors or traders may even use a smaller threshold of say 4%-5% to determine when to cut a stock loose. My portfolio would be even higher than what it currently sits at if I had only obeyed the rule of cutting losses quickly.
The overall condition of the market should be taken into consideration when trying to determine a personal threshold. For example, a 7%-8% threshold may be appropriate in a bullish market whereas a 3%-4% threshold may be appropriate in a bearish market.
Trading Indicators
One of the charting tools that I find extremely helpful when analyzing a stock’s price & volume action is the MACD Histogram Tool. The MACD Histogram Tool shows buying and selling momentum for the stock’s share price.
Now, there are hundreds of tools out there, but all of them are some sort of formula that usually involves price, volume or both. I’ve discussed this in previous articles. One such article titled “Technical Analysis & the Art of Voodoo” comes to mind.
The key take-away from this is to keep the selection of your technical indicators relatively simple. Select a handful of technical indicators that utilize price and volume in a couple of different ways. The 2 main technical indicators I like to use are moving averages and the MACD Histogram.
Trading A Gap-Down
This video will explain how to use a Fibonacci Retracement Tool to analyze a gap-down. Until I get a video on gap-ups posted, use the same logic only the opposite for a gap-up.
Volume Guideline for Penny Stocks
If I do choose to invest in stocks that fall under the $10 million rule (some of the penny stocks I trade in), then there is one general rule to follow – never have your purchases or sales for a day be larger than 10% of the overall volume for that day. If needed, break those sales and purchases into multiple transactions in order to not affect the share price with your own purchases or sales. You don’t want to be the “big institution” that comes in and drives up prices!
