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THE CHARTIST


May Price And Volume Be With You

05/06/05 11:32:30 AM PST
by Tim Ord

The relationship between price and volume is key to trading profitably. Here's an in-depth look.

Over the years, I have discovered that one of the best and most accurate tools in trading is the relationship between price and volume. I wrote an article in May 2004 for STOCKS & COMMODITIES that described how stocks and indexes react to previous highs and lows and what volume does to determine if that issue will reverse or rally through these support and resistance zones. The methods I discussed had a very high degree of success. Since they are one of the ways I analyze the markets, I decided to take a more in-depth look at price and volume relationships.

SUPPLY AND DEMAND
Richard Wyckoff, the legendary trader, once said, "The only fundamental factor that really counts in the stock market is the law of supply and demand." And it's so true! To illustrate this point I have chosen a few examples that have obvious visual volume expansion and contractions during rally and consolidation phases. For my purposes here, "demand" is high volume coming in on the buy side of the market, while "supply" is high volume coming on the sell side.

Take a look at a graph of Research In Motion (RIMM) in Figure 1. Note the supply (high-volume selling pressure) starting near $60 in late 1999 and gradually decreasing into the low of October 2002 close to the $4 range. As the stock price of RIMM was approaching the $4 low, supply weakened, suggesting that the low was nearing. Starting from the low in October 2002, demand (high-volume buying pressure) overtook supply and rallied strongly into April 2004. The high-volume down leg on RIMM confirmed the decline from $60 in 2000 to about $4 in October 2002. The gradual rally from $4 (October 2002) to $70 in April 2004 with gradually increasing volume confirmed the uptrend. You can see high-volume confirming price trend. Price can't go far (either up or down) without volume confirming that direction.

Figure 1: SUPPLY VS. DEMAND. The high selling pressure that brought the stock price down from the $50 range to $4 shows that supply has overtaken demand. The opposite happens when prices rise from $4 to $70.

Bema Gold (BGO)
The chart of Bema Gold (BGO) in Figure 2 is a good visual example of supply and demand. You can see how price increases as volume expands (red line) and price declines as volume decreases (blue line). The red lines represent demand and the blue lines represent supply. If volume is increasing as price is advancing and price is decreasing as volume is contracting, that means that the price trend is in a bull mode. With that in mind, you can come to the conclusion that stocks trend in the direction with the highest volume. Stocks correct or consolidate on lighter volume.

By measuring the volume between the swings and comparing it to previous swings, you can see the force of a particular move developing in the stock. In an uptrend, the stock should have higher volume on the rally phase than the correction phase. In a downtrend, the stock should have higher volume on the declining phase than the up correction phase.

Figure 2: PRICE VS. VOLUME. Here you see how price increases are accompanied by increasing volume and price declines are accompanied by declining volumes. This suggests that the trend is in a bull mode

The Nasdaq Composite weekly index ($COMPQ)
The 2000 top in the Nasdaq Composite could have been identified with the supply and demand characteristics (Figure 3); note the price range from August 1999 to March 2000. Volume expanded as prices rallied. This condition confirmed the uptrend.

An interesting development occurred on the decline from late March to April 2000: Volume expanded during that decline. Since volume goes in the direction of the true trend, this high-volume decline suggested that the energy (force) had switched from up to down, implying the bull market had ended.

After the April 2000 bottom, the Nasdaq made two feeble attempts to rally, but both rallies had weak volume and suggested the rally was not going far. Another decline started in September 2000, and you can see volume expanding as the decline progressed, confirming the downtrend. It takes practice to eyeball the rally phases and decline phases and match them with volume expansions and contractions to determine what direction the markets are really headed.

Figure 3: MARKETS DIRECTION. Getting adept at visualizing volume and price relationships can help you "eyeball" market reversal points.

To identify trends in the market, I pick out the swings (on stocks or indexes) and then measure the force between the swings. When I say force, I mean the amount of "average volume between the swings." By measuring the average volume between the swings and comparing it to previous swings, you can see the force of a particular move developing. In an uptrend, the stock should have higher force on the rally phase than the correction phase. In a downtrend, the stock should have higher force on the declining phase than the up correction phase.

To ascertain the average daily volume in a swing, add the volume between the swing high and low and divide by the number of days in the swing. This helps determine the force in that swing. You would then have to repeat the process with other swings and make a comparison with the other swings to find out which way the force is pushing. To make what can be a tedious process easier, I developed a software program to measure the average volume between swings. Now, with a single mouse-click, I can see the force behind a stock and which way that force is pushing.

TRADING RULES
The trading rules are relatively simple and few in number, designed to choose the optimum stocks for purchase and/or sale:

·To pick the strongest stock (in an uptrend), average daily volume should shrink close to 50% during a correction phase compared with the rally phase.
·To pick the weakest stocks (in a downtrend), average daily volume should shrink close to 50% during an up phase compared with a declining phase.
·A buy signal is triggered when a stock closes above a previous important low, where the current "Ord-volume" low shrinks near 50% or greater against the first important low. An "important low" is one that marks a bottom of an area where the price starts a sideways consolidation.
·A sell signal is triggered when a stock closes below a previous important high, where the current Ord-volume high shrinks near 50% or greater against the important high. An "important high" is one that marks a top of an area where the price starts a sideways consolidation.

Target price projections
An upside target for a buy signal will be the previous swing high. If volume is equal to or greater than the test of the previous high, then the next higher swing high will be the target and so on.

A downside target after a sell signal will be the previous "swing low." If volume is equal to or greater than the previous "swing low," then the next lower swing will be the target and so on.

PATTERNS LEADING TO BUY SIGNALS
Several examples can be seen in Figures 4 (BGO, an example of a buy signal) and 5 (YHOO, an example of a sell signal).

A bullish setup for BGO:
If you compare the price low of 2.14 (A) to a price low of 2.11 (B), you will note that volume was reduced by nearly 50%, suggesting that the down force was weakening. In addition, note that the average volume decline in the D leg compared to that of the C leg rally was significantly lower, which means the force to the downside was very weak.

In the rally from B to 2.43, you saw a twofold increase in volume and the decline from 2.43 down to the final low of 1.97 had half the volume of the previous rally. The buy signal comes at a close above the previous low of 2.11.

Figure 4: THE FORCE IS WEAKENING. A buy signal together with a strong Ord-volume on a rally confirmed the bottom.

PATTERNS LEADING TO SELL SIGNALS
On the price chart of YHOO in Figure 5, note the decline from the 500.13 level had more than a 300% increase in volume compared to the rally leg into 500.13. The new increased force to the downside implied the rally phase had come to an end. The rally from the 361 low to the 451.25 high had near half the volume of the previous leg down to the 361 level and showed that the force on the rally phase was near half of the decline phase. The sell signal comes on a close that is below the previous low of 361.

Figure 5: THE FORCE IS STRENGTHENING. An increased force to the downside indicated the rally had come to an end. Since the Ord-volume is about half of the previous downleg, a sell signal is triggered.

As you can see from these examples, volume is an important ingredient to determine direction of any tradable.

One of the most accurate tools in trading is the relationship of price and volume, and to understand it is to be able to improve your trading. It is clear that the two forces work together; price can't go far, either up or down, without volume confirming the direction. Like the forces of the Jedi and the Dark Side, one must balance the other. May the forces of supply and demand be with you!

Tim Ord may be reached at www.ord-oracle.com.

SUGGESTED READING
Ord, Tim [2004]. "Price + Volume = Price Movement," Technical Analysis of Stocks & Commodities, Volume 22: May.

Definitions
· Swing: A swing is a price high or low where the stock changes direction.
· Ord-Volume: Ord-volume measures the average volume between swings.

Current and past articles from Working Money, The Investors' Magazine, can be found at Working-Money.com.





Tim Ord


Company: The Ord Oracle
Address: 16928 Van Dorn
Walton, NE 68461
Phone # for sales: 402-486-0362
Fax: 402-486-0390
Website: www.ord-oracle.com
E-mail address: tim@ord-oracle.com

Traders' Resource Links
The Ord Oracle Market Letter & Ord Volume Software -- Advisory Services
Ord-Volume software -- Software


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