When you look at the big volume spikes shown in the following examples, ask yourself what could possibly have caused all this extraordinary volume activity and how might this affect the S&P 500 index. Quite simply, the market can react in one of two ways: either continue along its current path or reverse course and head the other way. Index values will always (sometimes immediately, sometimes with a delay) react to volume spikes, and the greater the magnitude of a spike (or series of spikes), the stronger the ensuing reaction. (The many complex reasons why sudden volume surge take place are beyond the scope of this article).
Example 1: Remember last year, when the long market downtrend finally reversed and switched to a steady up-trend?
Again, a volume analysis chart provides us with fresh insight. Three volume spikes (two large ones in July and October 2002, as well as a smaller VMA peak in February 2003) correspond with a distinct long-term trend change for the S&P 500. You could argue it was prompted by the outbreak of the war in Iraq. However, our volume analysis indisputably demonstrates that that index “was ready” to move up, given the large buildup of supportive volume, as evidenced by the two very significant volume spikes. It could also be argued that the new uptrend actually began on October 10, 2002 and that the January 2003 move to retest the recent lows was just a mid-term correction of the new up-trend.
Example 2: Do you remember the market action in March 2004?
On this 30-day chart, you can clearly establish that each major volume spike was followed by an index reversal.
Example 3: Fig. 3 shows that the discussed relationship between volume spikes and index reversals applies equally well to the short-term, not just to the mid- and long-term. Note how each volume spike coincides with an index reversal point.
Trading remains an inexact science, or perhaps more fittingly, an art. Every trader knows that no system or analysis technology is 100% perfect, and neither is volume analytics. We have just touched on the topic briefly here, yet the examples provided should have given you at least an idea of the benefits this proven and refined methodology could bring to your trading. If you would like to add volume-based approaches to your trading arsenal, please visit MarketVolume for further information. There is much to discover.