Volume: The Forgotten Leading Indicator

by AJ Monte CMT | 07/05/2018 2:07 PM
Volume: The Forgotten Leading Indicator

If you were to tune into your favorite financial television show, I’m sure it wouldn’t take long before you saw someone throw out a price forecast on one of their favorite stocks. Week after week, the fund managers line up to be guests on these programs in an attempt to showcase the next best investment or stock trade. Unfortunately, most of these forecasts wind up being wrong, leaving the unsuspecting viewer stuck with a losing stock position. 


For years, I hosted my own financial program, Wealth & Wisdom on PBS, and I’ve interviewed many financial experts. What I found most interesting is that their stock ideas always seemed to revolve around earnings forecasts and P/E ratios. The truth is if you are a swing trader and you’re using the fundamental data to predict a price move, you’ll most likely miss the move eighty percent of the time.


Don’t get me wrong, I’m not telling you not to look at the fundamentals, because I do believe there are many companies that have strong earnings and low debt to equity ratios, which usually turn out to be great investment candidates. However, when it comes to trading the markets, I’d rather focus on the technical indicators. Let’s face it, if you took a closer look at the fundamental reports that are posted on the Internet, you’ll find that most of the data is outdated, because most companies release their earnings reports on a quarterly basis. If you are making a decision to buy or sell a stock based on this information, your timing will most likely be weeks off the mark. 


After 36 years of trading the markets, I’ve found that the two most important leading indicators are price and volume.  When looking at the price, I prefer to use candle charts because they track four data points; the high, the low, and the opening and closing prices. As you develop your skill for reading candle charts, you will find it’s fairly easy to see who is in control of the price.  For the most part, green candles tell us that the buyers are in control of the price and the red candles tell us when the sellers are in control, while the price and the volume bars at the bottom of the chart tell us how strong the move is.  If you want to increase your percentage of accuracy with regard to forecasting the market, all you have to do is learn how to read the direction of the move through price and compare that to volume, as the force behind the move.


As a private pilot, I often use the analogy of flying an airplane to explain the importance of tracking volume as it applies to trading the stock market. Imagine you are sitting in the cockpit of your plane and you’re about to take off down the runway. Before the plane is able to lift off the ground, power should be set at full throttle, and you will need to keep the fuel moving into the engine while continuing to gain speed and altitude. If during your takeoff, you were to pull back on the throttle, the plane would start to lose altitude and the plane would quickly start heading towards the ground. In the world of trading, volume relates to a stock in the same way fuel relates to the altitude of an airplane. In other words, strong volume is interpreted as the driving force behind a healthy upward trend. A decrease in volume tells us the buying pressure is beginning to weaken.


The volume bars also give us an indication as to what’s happening on the sell side of the market. If a stock has been in a downward trend and you see that the volume bars have been steadily increasing, then this tells us the sellers are still very much in control of the price action. Always remember this before you put your money into a new stock position. If you make a decision to buy a stock while the selling pressure is increasing, then chances are the stock will continue to drop after you buy in.  I’ve always found that it’s best to wait for the volume to drop before buying into a new stock position, as this is an indication the sellers are losing their momentum.  Any professional trader will tell you, before a stock starts going up…it will first have to stop going down. Remember, you don’t want to catch a falling knife, because if you do, you will most likely get hurt.


Once you have become familiar with reading the volume bars on a chart, I would then suggest you learn how to draw simple support and resistance lines. This will help you identify where the supply and demand areas are for a stock. Unfortunately, most inexperienced traders have bought in to the “buy low – sell high” mentality. Like I just mentioned, if you are trying to buy a stock that is being controlled by the sellers, odds are the price will continue to drop after you’ve bought it. Instead, it’s best to wait for a bounce off of support after the volume drops and then buy in after the buyers have taken control of the price action. This puts all of the momentum behind you which, in turn, increases the probability of you making money as you BUY with THE BUYERS.


Of course, there are other indicators you can look for, but I’ve always believed that when it comes to reading the market…Less is More. That’s why I always teach people the K.I.S.S. Principle…Keep It Super Simple.


Feel free to visit The Market Guys video library where you will find short educational videos called “Market Shots”. The length of each video ranges between 6 to 8 minutes long, making it easy for you to fit these lessons into your busy schedule.


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