Trading volume gives mixed signals -- at least that's the way it seems to me.
Interpreting the Volume
Increasing volume in an up market (i.e., when prices are in an increasing trend) is bullish and portends still higher prices. However, there comes a time when the volume is so great that it reaches blow-off proportions. That's not bullish for the market and in fact portends a top. (Some technicians try to detect the top by using cycles).
Very often, too, after a pullback from the high, prices go even higher, but are accompanied by lower volume. This can happen in a double top or head and shoulders formation, for example. (These patterns are realized when prices break through the neckline to the downside.)
In a parallel way, increasing volume in a down market is bearish and portends lower prices, still. However, there comes a time when the volume on the downside is so great that it reaches blow-off proportions. That's not bearish for the market, and in fact portends a bottom. Very often, too, after a rebound from the low, market prices go even lower, but are accompanied by lower volume. This can happens in a double bottom or reverse head and shoulders formation.
Again, in a bull market, lower prices on decreasing volume is bullish. It shows that not many people are willing to sell at the lower prices -- selling pressure is diminishing. When the volume dries up, the advance normally resumes.
And in a bear market, increasing prices on decreasing volume is bearish. It shows that not many people are willing to buy at the higher prices. When the volume dries up, the decline normally resumes again.
It's instructive to compare this view with that of Charles W Smith.
Divergence of Volume from Price
At the top of a market, what normally occurs is distribution, which is to say that stocks are passing from strong hands to weak hands. At a bottom, it is accumulation, meaning stocks are passing from weak hands to strong hands. In either case the momentum is changing direction.
Accumulation and distribution are the basis for a divergence oscillator called the Chaikin Oscillator. Here's what Bauer and Dahlquist have to say about it:
1. Accumulation is said to occur when a stock closes above its midpoint for the day [calculated as (high + low)/2]. The closer the closing price is to the day's high, the more accumulation has occurred. On the other hand, distribution occurs whenever the stock closes below its midpoint for the day. This distribution is greater as the stock closes closer to its low.
2. Volume is viewed as the fuel that powers rallies. Therefore, a healthy advance is powered by rising volume and a strong volume accumulation. If low volume accompanies rising stock prices, not much fuel exists to push stock prices higher. In addition, low volume will usually accompany stock price declines. Toward the end of the decline, volume may rise as worried institutional investors liquidate.
3. Analysis can monitor the flow of volume into and out of the markets using the Chaikin Oscillator. Chaikin claims that comparing this flow to price movements can help identify both short-term and intermediate-term tops and bottoms.
The Chaikin Oscillator uses an accumulation/distribution line as the sum of the accumulation/distributions:
AD = åadi, for i = 1 to P,
or for a predefined range, P. The terms adi over the period are defined as follows:
adi = (((Closei - Lowi) - (Highi - Closei))/(Highi - Lowi))/Vi:
Each day, for example, you take the difference between the closing price and the low, the difference between the closing price and the high, subtract the latter from the former, and divide by the difference between high and the low. This gives the fractional value that finishes above or below the close for the day. The value is then divided by the volume to yield the movement per unit volume.
A ten-period and a three-period exponential moving average of the accumulation/distribution line are calculated, and the difference between them is the Chaikin Oscillator:
CHA = 3-period moving average -10-period moving average.
When price movement and the Chaikin Oscillator movement diverge, a trading signal is generated.