Significance of Volume

Significance of Volume

Volume is used to confirm trends and chart patterns. A price movement whether up or down with comparatively higher volume is consider much stronger than a similar move with weak volume. Therefore, in order to explore for large price movement, the volume should also be examined so as to see whether it tells the same story.

Now in order to illustrate how this works let us consider a situation where a stock jumps 10% in one trading day where a long downtrend has been observed over a period of time. Does this high indicate  trend reversal? This is where volume helps traders to get a clear picture of the situation. A high volume during the day relative to the low average daily volume is a sign of probable trend reversal where if the volume during the day is below average, this means that there is insufficient evidence to support a true trend reversal.

Note, volume should move with the trend. If prices are moving in an upward direction then volume should increase accordingly and vice-versa. Weakness in trend is seen when the previous relationship between volume and price movements worsen. For example, if the stock is in an uptrend but the up trading days are marked with lower volume, then it is a sign that the trend is starting to lose its hold and may soon end.

Divergence happens when volume tells a different story which refers to a contradiction between two different indicators. Example of divergence: Upward trend on declining volume.

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