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BEWARE:
RISING PRICE AND FALLING VOLUME
After a brief detour into "buy on
stop" orders last week, I want to continue with the principles of
volume analysis. This week, I want to draw your attention to the danger
raised by a stock when its price is rising, but at the same time its
trading volume is trending lower.
But before we get to this, as a brief refresher, here are the major
points we've already covered regarding volume in recent issues:
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Traders must always look at price
patterns in conjunction with their associated volume pattern, never
alone. A stock may appear to be in a head and shoulders pattern, but
the volume pattern must confirm that analysis.
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Careful analysis of the volume of
selling that occurred above current resistance will help you
estimate how long a stock will stall at that level.
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Well-above-normal volume is essential
when separating a true from a false breakout above resistance.
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Well-above-normal volume on the break
of a key support level is likely to keep the swing trader from
making the mistake of shorting into a deceptive "spring"
formation.
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Climactic volume can occur after a
sustained downtrend. The retest of the support level of the selling
climax can provide a good trading opportunity if it is accompanied
by low volume (as compared to the selling climax).
Why is it so vital to be aware of volume
when the price of the security you're examining is rising?
There are few events so satisfying to the swing trader as seeing a stock
one has purchased go in the "right direction" -- the direction
you predicted. It is, after all, changes in price that make traders
money.
Let's say you are long a stock and it is trending steadily higher. You
come home, bring up the chart on your screen and note that the stock is
up another 2% on the trading session. Not much need to analyze it
further, you may think. It's going in my direction and it's obviously in
an uptrend.
This seduction of rising prices, however, can distract the swing trader
from doing what he/she should be doing -- a complete, thorough technical
analysis of the trading position with particular attention to its volume
pattern. If a stock is truly in a healthy uptrend, then volume should
rise as prices rise. If this is the case, then the volume indicates
that buyers are chasing the stock. This increases the probability that
the uptrend will continue.
Volume, however, can be very erratic. A light volume day on the market
may easily translate to a light volume day in your stock. It is unusual
for volume to rise every single day during an uptrend. The solution to
the dilemma is to draw a trendline on the volume chart in the same way
you draw a trendline on the price chart. The two trendlines should be
moving in the same direction. If they are not, then you probably have a
situation called "negative volume divergence." Price is
rising, but volume is declining. This divergence indicates that even
though demand still outweighs supply, buyers are not willing to pay up
to own the stock. Such a pattern can signal that the uptrend is running
out of steam and should put the swing trader on alert for a trend
reversal.
Recent trading in storage giant EMC Corp. (EMC) is instructive of the
dangers of paying attention only to rising prices. As shown by the chart
below, EMC bottomed in late July. It then began an Intermediate uptrend
(defined as a trend that lasts between three and 13 trading weeks). At
the beginning of the uptrend, volume was very strong, with many days
being above the daily average.
In mid-September, EMC almost touched $14.00,
formed a doji candle (this indicates indecision on the part of buyers),
retreated and found strong support at $13.00. From here, as is shown in
the circled area, the stock rallied again, retesting $14.00. During this
circled period, the stock finished in positive territory in five of six
days. I've drawn a trendline under this area of the chart.
Now notice the volume pattern. During this rally, volume was light. It
was consistently under the average daily volume level. Secondly, and
perhaps more important, it trended down while price trended up.
Note the down trendline I've drawn on the volume chart during this
six-day period.
Shortly after this period of negative volume divergence, EMC experienced
a sharp sell-off and broke its Intermediate uptrend line. Even before
the trendline break, however, a trader holding EMC long (one with a firm
grasp of important volume principles, of course) should have been on the
alert for a potential reversal.
A rising price brings smiles to the faces of traders who are long.
However, when prices rise during a period of declining volume, this
pattern can eventually cause tears of frustration. As such, alert swing
traders should always be on the lookout for negative volume divergence.
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