How to Day Trade Using Price Action: Volume analysis continued – Ep. 8

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Today we’re going to continue where we left off last time. We’re going to continue with the Volume analysis and combine it with trends and trendlines. Supply and demand.

Volume speaks volumes about the market – sorry for the silly play with words – but that’s the way it is. It speaks volumes about the relationship between supply and demand, and about the quality and strength of trends and movement in the market.

We can use this information to our advantage and gain an edge over other traders who don’t know how to read volume.

In the last episode we had a look at how we want the volume to increase and be high in the up moves of an uptrend, and diminish and be lower in the pullbacks. The up-legs are strong, the pullbacks are weaker. That tells us that the uptrend is strong and healthy.

Trends that do not have enough volume will not last for long, because that means there is not enough supply or demand to keep trending. Instead it is likely that we get a period of consolidation and sideways movement, or a new trend in the opposite direction.

When we draw trendlines and trend channels we can use the volume to get a better understanding about how strong that trend line is. If the market reverses at the trendline and the volume picks up on the move away from the trend line, then we can have confidence in that trend line. And once the trend line breaks, we want that to happen on a big candle with big volume – the market should show determination. And after the break of the trendline we want the volume to diminish on the test of the trend line. The market is going to test that previous support or resistance. The market is going to test if it is able to move back inside the trend channel, or back above or below the trend line. So this pullback or rally back towards the trend line after the break out should happen on lower volume. Again, this tells us that there is no willingness to move back where it came from, there is not enough supply or demand required to do so.

So let’s now have a look at another way to analyze volume.

How can we tell if a trend is going to end? We’re never going to reach 100% certainty that a trend will end at some specific price – if we would have that ability we would all sit on our own private islands in the caribbean right now — but we do have a method to analyze the charts that will give us reasonably high – i would even say high – confidence in knowing that a trend is at its end, at least for the time being.

So let’s consider an up trend. The same will be true with downtrends, but let’s start with the uptrend as it is easier to grasp what I am about to explain.

So we know we want the up-legs to be stronger and the down-legs to be weaker in an uptrend, right? But how do we know that the upleg is going to end, or if the uptrend is going to end?

Let me give you an analogy – I just love analogies, the sillier the better. Silly is simple, simple is easy.

So we have Mr. Market here running up the side of a mountain.

The hill sometime becomes steeper and steeper, and sometimes there’s an area that is flat or part that is easier, even going downhill before going up again. So the side of the mountain is just like an uptrend, right? In the market you’ll have up-legs, down-legs and periods of consolidation.

Now if you have ever walked up the side of a big mountain you’ll know just how exhausting it is. You need the be in pretty good shape to do it. I was visiting the Swiss Alps some years ago. At that time I was is pretty good shape – I was jogging regularly and going to the gym, but I was still getting pretty darn exhausted as we went hiking in the mountains, the Alps.

So as mr market starts walking up the mountain side the path gets steeper and steeper and steeper until finally he reaches the mountain ridge. The volume bars shows the effort he is making. The volume bars get bigger and bigger. Mr. Market is getting more and more exhausted. Right at the top he makes the final push, one last big effort to get up to that ridge.  

That’s exactly what happens in your chart as well. The bars move higher and higher and the volume stays high, or picks up and increases. At some point there will be one last push, one big candle on very, very high volume. This is sometimes referred to as a Buying climax. This buying climax exhausts the market completely, because it happens on a big candle, or a few big candles, and very high volume.

What happens during the buying climax is that all traders notice that the market is moving up. Everybody who watches the chart will notice the big move that the market is making. It’s moving up fast, and they all want a piece of the action. They don’t want to miss out on the big move that the market is making, so everyone’s rushing in and buying. The market makers are able to raise the price, there is a lot of demand, so the candle is getting bigger and bigger, and this causes even more traders to join in on the buying. So it’s a kind of a self-fulfilling prophecy.

This means the volume is getting bigger and bigger as well, because more and more traders are buying. The more buyers and sellers that participate at any given time, the more contracts or shares that change hands, the bigger the volume will get.

Then when all traders who wanted in, when they have bought everything they wanted to buy — then there is no more demand left. Nobody wants to buy anymore.

And what happens when there is no more demand? Well, the prices will stall and consolidate. Or if there is supply coming in – sellers entering the market – the prices will fall. There will be a pullback or a sideways consolidation.

The buyers who bought close to the top, they will sell because they aren’t seeing any profits on their positions. It doesn’t make sense holding on to a trade that does not produce profits. And the traders who bought at lower prices will sell to secure their profits. And of course the traders who bought right at the top will start to have losing positions and their stops are starting to get hit.

So all of this is building upon what we have learned in a previous episode — when the demand overcomes supply – the prices will rise. And when supply overcomes demand, the prices will fall.

We’ll continue on this topic in the next episode, so make sure you subscribe, and if you have any questions feel free to use the comments here below. Until next time, bye bye.