Volume And Price Relationships

Volume is the number of shares traded in a given period of time, such as an hour, a day, a week, and so on. Reported volume figures represent an equation between the number of shares bought and the number of shares sold—sell orders must always match buy orders. If there is an imbalance of demand to buy shares over sell orders at any time, equilibrium is restored by an advance in price to a level where enough sellers are attracted to restore the equilibrium. If
there is an imbalance of sell orders (supply) over buy orders (demand) at any time, prices decline to a level where enough buyers are attracted to equal the number of shares for sale.
Price trends, up or down, tend to feed upon themselves, as rising prices attract more buyers and falling prices attract more sellers. In other words, buying waves and selling waves tend to snowball or follow a bandwagon effect. The bandwagon effect occurs because the stock market is a manifestation of mass/crowd psychology in action. Crowd behavior snowballs on account of contagion, imitation, suggestion, convergence, and a strong leader-followers relationship.
A bandwagon of crowd behavior tends to form a bell-shaped curve. A move starts out with a few innovative buyers or sellers, who are followed by a bulge of other buyers or sellers who join the move, after which activity tapers off as laggards are recruited from a shrinking number of remaining potential buyers or sellers. In broad, general terms, the model of mass/crowd psychology in action is a bell-shaped curve of volume. The start of a move is represented by the left-hand tail of the curve, the bulge of activity occurs around the middle, while the termination of the moveoccurs on lighter relative volume represented by the right-hand tail of the
curve.

The major price/volume relationships are observable by integrating the bell-shaped curve of volume with the S-shaped curve of price, at threepoints:

(1) At the birth of the markup or markdown phases, the volume expansion confirms the price movement;

(2) the bell-shaped curve shows that the volume peak leads the price peak on the S-shaped curve;

(3) volume diverges from price as price crowns over or rounds under as the move comes to an end. In sum, the bell-shaped curve reveals three useful generalizations regarding volume and price movement:

1. Increasing volume with increasing price spread on the upside means higher prices to follow.
2. Increasing volume with decreasing price spread indicates a price reversal is imminent.
3. Initial down thrust with wide price spread and heavy volume indicates lower prices to come.

Heavy volume with price not giving further ground following a protracted decline indicates that the decline is nearly complete—a selling climax has been reached; accumulation is probably commencing. Climactic volume following a long up move indicates that the termination of the up
move is nearing, particularly if the heavy volume is not accompanied by further price progress; thus, the distribution phase is starting. A breakout from a trading range in either direction when accompanied by heavy volume and wide price spread indicates the validity of the breakout. Further movement is likely to take place in the direction of the breakout: markup or markdown confirmed.

Generally, large relative volume accompanies the terminus of a move. Small price advance on relatively large volume is evidence that smart money is moving counter to the trend—their sell orders or buy orders are overwhelming the less knowledgeable public participants. Turns occur
when there is considerable volume effort and comparatively little price result. Alternatively, when small volume occurs at the bottom (top) of a considerable decline (advance), or at the bottom of a reaction or small slip (top of a small rally), it usually indicates a lack of pressure (power)—a drying up of selling pressure or buying power. However, price declines on small volume are frequently bearish. Whereas bear moves terminate in narrow price moves with the accompaniment of low volume and listless trading, bull moves terminate with relatively wide price swings accompanied by high volume and more or less feverish trading activity, although
volume may be less at the end than in earlier stages of the bull market. It is the change from dullness to activity, or the reverse, that is important—perhaps more important than the absolute level of volume.

Some students of the stock market argue that volume plays a much more important role than simply corroborating a price movement. They contend volume takes precedent over price because it leads price. Key exponents of this philosophy are followers of the on-balance volume
(OBV) system for predicting prices. This philosophy contends that volume acts as a momentum variable which carries over to subsequent price movement. Recall the earlier analogy that volume is to the price movement of stocks as gasoline is to the automobile. Remember that an
increase or a decrease in volume is significant. Gradual or sudden increases or shrinkages in volume will assist you in detecting turning points, determining the trend, timing when to open or close a trade and when to change your stops, and identifying when a move may be culminating
or about to culminate. Whereas price deals with the “what” of the stock market, volume deals with the “how.” How are prices moving?
Are they moving upward on comparatively light volume? Are they going downward on heavy volume? Are they going nowhere on massive volume?
Remember that changes in the market commence internally and work outward; internal volume behavior precedes external price behavior. In turn, volume and price precede external fundamentals and news. In my own trading I have found this on-balance volume information to be of value for obtaining a solid indication of the present position and probable
future trend of a market.