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Two Views on Volume

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Stop with the "Low Volume" Arguments!
Michael Gayed

Time and time again I hear pundits talk about how the rally isn't "real" because it is happening on low volume. But when challenged, no one seems to have any proof that volume has predictive power when it comes to market trends. Volume does not create conviction -- higher prices do. If anything, low volume suggests a certain amount of inefficiency and underreaction in the direction of the prevailing trend that is underway.

Why? Because volume has a funny way of peaking at significant turning points in markets, and not in the middle. More so than that, though, imagine that every single stock reverse split, such that the price of every single stock has now been doubled with no change to market cap. Assuming constant dollars, volume would be cut in half. Does that mean anything? Absolutely not.

Market internals continue to look healthy, as my upcoming Lead-Lag Report will show. This trend is real, and everything I look at suggests the move higher can continue to the Summer Surprise. Keep watching the cyclical trade for leadership -- I still maintain that a meaningful move is coming in emerging markets any day now as risk-taking overseas increases, and bulls grow more confident.

Thoughts on Volume
Marc Eckelberry

As a day trader who makes extensive use of volume analysis, Michael Gayed's note on volume is quite correct in that low volume is not a hindrance when it comes to momentum. What matters is when higher volume occurs.

There are two types of general volume patterns to note: breakout/breakdown or end of trend.

A Breakout/breakdown occurs when the value area is left behind, smart money is already in, and the pack follows. Volume can get thinner as we progress.

End-of-trend volume is when smart money gets out and reverses course. Usually, that is when you spot dumb money low volume still stuck in the now-dead trend. This is particularly noticeable at bottoms: not a single major low is produced without this effect. A huge increase in volume (so-called capitulation, but in fact it is smart money covering shorts and flipping long), often followed by a lower low on less volume with dumb money still shorting: a major buy signal. (see ES chart example with June lows).

The key is to understand where extremes lie; that is when a burst of volume is a major red flag in terms of trend change. This pattern is a little less reliable at highs, but when it happens, it can be extremely violent without a higher high, the so -called blow-off top.

For the most part, though, highs take longer to form and can test one's patience as the mass of traders out there mostly trade the long side. In the same daily chart, note how we got a volume surge in early August as we broke through resistance, which was clearly defined as the July double top. Note that the heavy volume occurred the day before, and that the bar closed well off lows. The next bar was the breakout bar. As you can see, it is a heck of a lot easier to time bottoms in the thick of the action with volume than it is to spot highs. This is where volume profile study comes in, but that will be for another post.

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POSITION:  No positions in stocks mentioned.