Today I want to talk about a foundational concept that every trader should have a solid grasp on.
I’m talking about volume.
See, the simple truth is that the price of any security CANNOT move with volume.
This is true whether we’re talking about a stock, an ETF, a future or option contract or anything in between.
One analogy I think expresses this idea beautifully is that volume is the fuel that drives the market…
And the more fuel there is, the greater the momentum.
But here’s the thing…
This isn’t just my opinion.
In fact, a study of market volume published in 2001 out of The Wharton School of the University of Pennsylvania considered market prices over a 30-year period.
One of its major conclusions was this:
“Stocks whose trading activity is unusually large over a period, tend to experience large subsequent returns.”
In other words, when there is unusually high volume in any given time period (5 minutes, an hour, a day, a week)…
Then price tends to continue in the same direction in the future.
This principle has been shown to apply to all financial instruments and markets, so it applies to currencies, commodities, indexes, equities and ETFs.
It’s also a recognized fact that when prices are rising, the market will not fall purely as a result of low volume, but will simply move sideways as it takes a breather.
On the flip side, any reversal from a falling market cannot occur without an increase in volume.
In other words, volume confirms the strength of a trend or suggests its weakness.
Here’s an example…
If the market is rising, and we see volume increasing, then this suggests that we have a strong trend supported by an increasing number of buyers.
Of course, if it were selling volume coming into the market, then prices would fall, or perhaps move into sideways congestion before falling.
But since that’s not the case, we can conclude that the volume is BUYING volume, and we can expect the trend to continue.
Conversely, if we have a rising trend but falling volume, then this is WEAK.
Because as we’ve just discussed, if the buyers are still in the market, then this would be represented by rising volume.
Therefore, a rising trend with falling volume signals that the buyers are no longer interested.
The trend is running out of steam and becoming exhausted…
And that’s the first sign of a possible change in trend.
Of course, you already know that being able to identify a trend… and stay with it for as long as possible… is the key to successful trading.
But as a retail trader, it’s difficult to accurately gauge what volume is really telling you when you’re at home in front of a trading computer.
In fact, the pit traders on the floor of the exchanges have a massive advantage in this department that I’ll talk more about in a future issue.
For now, though, if you want to learn more about a powerful set of volume-based indicators that have helped everyday, blue-collar traders transform their lives with wild success in the markets…