Lower Volume
Be on the lookout for volume to begin decreasing or slowing as the price continues in the later stages of a trend as this shows a possible reversal, pause or at least an exit point. Most likely this is a pause which indicates a further continuation of the existing trend after the congestion/retracement. This is in contrast to observing high volume at the latter stages of a trend which would be more indicative of a future reversal since this would indicate that participants were liquidating their holding. A decrease in volume entering congestion/retracement simply means participants are still holding on for the next leg in the same direction so you would want to hold on to your position or enter/add at this point.
A true (permanent) top or bottom formation’s reversal should show high volume AFTER/ON the reversal AS WELL AS the trend PRECEDING the reversal. If it shows light volume AFTER/ON the reversal then this means that the original trend will resume and the trend is not going to reverse i.e. it is simply a pause. This then is how you tell if it is a temporary or permanent top/bottom or merely a pause in the trend i.e. looking at the nature of the volume both BEFORE and AFTER/DURING the top/bottom formation i.e. what volume is doing at the latter stages of the trend AND what volume is doing AS the price reverses. This before and after analysis determines whether price will temporarily retrace/congest and continue in the direction of the original trend or whether is will permanently reverse into the opposite direction.
During the latter stages of a trend if volume dries up as price continues to rise – be careful of this since a reversal usually takes place the same as in a volume crescendo except that in this case there may or may not be a spike before the volume dries up. If you see advancing prices, and declining volume then you should short or exit longs. Remember, if prices are rising, volume should be rising if in an uptrend, and then volume should temporarily decline during a decline or consolidation in price. Similarly, be careful of low volume as prices continue to decline in a bear market as you should be expecting an upward rebound once buyers finally step back in and all the sellers have disappeared. This paragraph describes volume activity BEFORE/DURING the reversal (permanent) or retracement/congestion (temporary). It describes what might happen in the future AFTER/ON the top/bottom. Therefore this is an early warning BUT not definitive. To really know for sure, you have to watch volume AFTER/ON the top/bottom as described in paragraph 2 above.
Low volume price advances (or declines) really say that the buyers and sellers are at equilibrium which can’t last for long before one side will dominate again…and it is in opposite direction of which direction the previous trend was moving but again, the key appears to be what happens AFTER/ON the top/bottom as described above since low volume drying up action could just be a temporary pause rather than a permanent reversal.
What the above is saying is that if you see the opposite to the way volume should be strongly or at least STEADY AND CONSISTENT acting DURING a trend, then beware of either a reversal or pause. The general theme is that if you see lower volume at tops/bottoms as market price advances, then be on the lookout for some kind of change be it temporary (retracement/congestion) or permanent (reversal). This is so because you should only see low volume on little or no price movement. Remember it like this: low volume = low price movement. If low volume accompanies price movement then this can’t be sustained for long and a correction will occur.
However, light volume doesn’t necessarily guarantee a price retracement or reversal if price is only channeling or moving slightly because this is what light volume means i.e. light volume reversals should only occur when price is accelerating in some direction, not when price is already languishing. Further, the bias is that if volume is light, then price will likely turn down, because fear is a more important motivator than greed so people watching light volume are more inclined to sell than buy. Hence the axiom that the market will fall from its own weight, whereas to advance it needs heavy buying pressure.
So the key is that if volume is declining and price is retracing or going into congestion AFTER the pivot, then the price will likely continue on its previous trend path. If price is retracing under high volume AFTER the pivot then a new trend in the opposite direction is underway and the reversal is permanent since only minor corrections should occur under light volume. If volume and price are both advancing (but not extremely volatile) BEFORE a pivot then price will continue in the direction of the existing trend and will only temporarily retrace/congest. If volume is declining and price continues to advance BEFORE the pivot, then expect a reversal or retracement in the future that might be permanent rather than a mere correction…again, look to AFTER the pivot for volume characteristics to confirm the price direction. But, if volume is extremely high in the direction of the prevailing trend BEFORE/ON the pivot, then a permanent reversal will occur (i.e. climax.)
LOOKING AT volume patterns BEFORE price reverses
This paragraph describes volume patterns BEFORE price reverses i.e. WHILE price is STILL running in a trend. At the later stages of a bullish move, you can have either buyers (demand) drying up or more sellers (supply) appear as the move ends. You can tell who is in control by the fact that as price continues to rise but is losing momentum (rounding off), and ranges continue to narrow:
a) Increasing volume means that more sellers are appearing.
b) Decreasing volume means that buyers are not any longer available. Low volume leading up to the top pivot indicates that demand is drying up.
Both conditions indicate the trend is going to reverse. The important difference in these warnings is that if there are more sellers (supply) then this is more indicative of a price decline than demand drying up. It indicates that the decline will be greater once the rally is over since the bears are taking over. This in contrast to demand drying up where the supply side is not in control i.e. it only means that the buyers are less interested in higher prices AT THIS TIME. The drying up of demand as evidenced by small volume as price advances to a top therefore might only be a pause in price since these owners are not selling and no new fresh sellers are shorting. If the owners were selling, or there was a perceived top by the bears who would be shorting, then the volume would be high. The higher probability short would then be to watch for tops forming on higher volume as opposed to volume merely petering out. Remember that this action to be looked at is as the rally is still continuing i.e. the ‘before’ detailed in paragraph 2 and 7. It is not on the reaction that follows the top (i.e. the ‘after’) in which case it follows the general rules e.g. if the reversal has high volume, then the trend will be down as compared to light volume on the reversal which would indicate a mere correction with the original bullish trend continuing. The same scenario in reverse occurs in a downtrend i.e. diminishing volume when price is contracting while still in the downtrend indicates that sellers are scarce and if volume is increasing while price is rounding/ slowing towards a bottom, then demand is in control as the shares are gobbled up as evidenced by the high volume. Therefore high volume during, or at the end of a downtrend would provide higher probability of a significant reversal to begin a new bullish trend. Light volume at bottoms shows that supply is drying up and taking the pressure off of selling which likely will lead to more selling.
Volume Patterns AFTER Price Reverses
This paragraph describes volume patterns AFTER price reverses. Wyckoff states that AFTER a significant decline or selling climax, if you see price jump up on light volume this proves that the sellers are gone and a bullish trend will begin. He says that if you see this rally to #2 on light volume, then you probably will get a reaction on light volume back down to point #3 which won’t take out the selling climax low #1 point. It is after this that you get the high volume coming in as the accumulation begins. Similarly at a top, light volume on the first decline says that the buyers are gone and that sellers are not pressuring the market but that the trend will turn bearish. The next rally on light volume should not take out the buying climax high. Then you should see heavy volume come in from the sellers to indicate the bearish trend is on its way. If heavy volume comes in immediately on the firs reaction then there probably won’t be a 1-2-3 or double top style of correction so you would have to move much quicker than if you see a light volume correction – same for bottom. So light volume AFTER a crescendo or climax tells you that a pause (double top/bottom, 1-2-3, congestion etc) is likely to occur whereas heavy volume AFTER a crescendo/climax tells you that the market is going to reverse into an opposite trend immediately.
This volume matrix shows a price direction when looking at volume at LATER stages of the trend shortly BEFORE the Hawkeye Pivot into a retracement:
Price Direction
|
Volume At Later Stages of Trend Before Pivot
|
Before Pivot
|
Higher
|
Lower
|
Up
|
Bull continuing
|
Pause or possible reversal
|
Down
|
Bear continuing
|
Pause or possible reversal
|
Volume Patterns
Another distinction of when it is likely to see low volume reversals are when either or both of these conditions exist:
a) After a slow or irregular price advance (or decline if the trend is down) on low volume.
b) After a period of dullness where prices are channeling in low volume.
The fact that both occur under light volume indicates that market participants are impatient so one of two things may occur:
a) The impatience of buyers holding stock begets selling as evidenced by higher volume or,
b) Both demand and supply dry up so the market falls under its own weight as evidenced by light volume. This scenario usually doesn’t result in a deep decline but more of a channeling dullness with light volume up and down within the channel until there is a decisive turn resultant from news etc breaking the indecision.
To determine whether a correction (or going into CONGESTION WITHOUT A CORRECTION) is a retracement or a reversal, not only do you look to see that volume is light, indicating support of the prior trend, you also want price to confirm it by having price breakout from the pivot that gave rise to the correction i.e. the breaking above/below of the #1 pivot if it is only a retracement. If it is a reversal then price should break above/below the #2 pivot of a 1-2-3 or double top/bottom. Many times in the ES you see an advance under volume, and then price simply channels sideways AFTER THE ADVANCE without a downward correction. When this channeling occurs, if you see little or no volume for several 625 tick bars, then expect the trend to continue on its original path. If you see the channeling under heavy volume you have to try to determine if is going to break up or down – usually it reverses from the original trend. Dullness after a rally in price under steady volume usually means a resumption of the trend.
High Buying Volume
High Buying Volume – Distribution by the strong hands. Without price increasing further AFTER PRICES HAVE BEEN RISING means that this is a resistance level and that price is going to decline because there are more sellers absorbing all the buying volume which eventually dries up the buyers thus moving prices down. This might not be a reversal point as price often declines into a consolidation and then eventually breaks price to the downside after the buyers become frustrated and stop trying to increase price. The key here is that if you see heavy volume but price isn’t increasing at the same rate, then beware that distribution is occurring and prices will decline. The big price increase (upthrust or spring – end of a top) on high volume is the other precursor.
High Selling Volume
High Selling Volume – Accumulation by the strong hands. Without price decreasing further AFTER PRICES HAVE BEEN DECLINING means that this is a support level and that price is going to increase because the buyers are absorbing all of the sellers’ shares which eventually dry up the sellers giving way to a price advance. Again, this is usually a consolidation phase which should lead eventually to an upside breakout when the sellers are frustrated, exhausted or simply not enough of them available. The key here is that if you see heavy volume but price isn’t declining at the same rate, then beware that accumulation is occurring and prices will eventually rise. The big price decline (shakeout or selling climax – end of a decline) on high volume is the other precursor.
Other Price Patterns with Volume
Watch for greater than 2 times the standard deviation of volume on a narrow range bar where the close is less than the open after a large run up as this portends a reversal to the downside. Similarly, after a bear market and you have the close greater that the open, large volume and narrow range bar, this is a reversal to the upside.
Watch for BOTH light volume AND a very narrow range as this is a prelude to an explosion out of the small range bar in one direction or the other
