What Does Volume Tell You?

Now I put the Volume indicator on the chart below. Red Bars mean the price closed lower than the day before and green bars me the price closed higher than the day before. It’s a good visual indication of the strength or weakness of the market.

At the 1 point, there was little change in the Volume and the price went sideways. Price had to break out one way or the other. Price broke out to the downside and there was not a big change in the volume. I will talk a lot more about this later in the course.

After the price dropped and formed the 2 point. Notice that Volume had been dropping a little too. The 3 point was confirmed with a lower high but it had very little Volume before it formed. To me, this would indicate some profit-taking, especially when the price did not make a higher high. Then the price dropped again and formed the 4 point. Volume actually dropped for the most part between the 3 and 4 points. To me, this is confirming a weak market that almost no one had an interest in.

After the 4 point was formed, the price started to rally and we had a little spike in volume. Usually, but not always a spike up in Volume confirms a rally. In this case, it did not hold and the 5 point was formed and Volume dropped. Notice the big spike in Volume at the 6 point? What should that tell you?

Now that we have seen volume in a downtrend, let’s look at the same chart in the next lesson for an uptrend.

I’m going to put the same chart below and we can look at the market as it made an uptrend.

Notice the spike up in Volume when the 6 point formed? Well just before that spike up you can see that volume was increasing. This, in most cases, is a signal that the trend is about to change. If I had been short at that time I would have tightened up stops expecting a reversal was near.

Then an ascending channel started but until it broke past the 5 point technically it was still in a downtrend. But when it broke past the 5 point the downtrend was broken and formed the A point on the chart.

However, look at the Volume increasing before the A point formed. The uptrend was confirmed when the C point formed. Why? Because price had to have a higher low which it did at the B point. Then price stayed pretty high and formed the C point then Volume AND price dropped, forming the D point, and then Volume took off again and so did the price.

Look at the chart again below. Notice that the price increased but Volume started dropping. I drew a line on the chart to point out how the volume was declining.

I want you to think about what this chart is showing you. Can you see that in the downtrend there was low Volume most of the time and then during the time between point 6 to point A there was an increase in Volume AND price. Volume broke up again at the B point until the C point and then dropped along with price until it stopped at the D point. (Notice that the D point and the 5 point were at the same price. Resistance became support. This happens a lot if you will look for it. When that happens I call it a Common Number. Keep an eye out for them.

Now pay close attention to what happened at the D point. Volume AND price shot straight up and held steady until the E point formed. But at the E point there was a very big Bearish Candle. It’s called a Bearish Engulfing Candle because the body of the Candle engulfed the body of the previous candle. This is a very Bearish candle by the way.

During the time the D point formed and the E point formed volume was still headed up but did not take out the previous Volume high. It actually closed low (red Volume bar) and then back up but like I said it did not take out the prior high.

Notice the slope down in Volume after the D point was formed. To me, it’s telling me that this rally may not be that strong, even though the price was going up. The rally may hold and only time will tell. It’s been a big rally and has yet to make a “big” pullback from the E point. I would not call the F point a big pullback.

Prices when they go up or come down, will more often than not make a 50% retracement and even a 61.8% pullback or retracement. This is just normal price action. More on this later.

If you are like me, I have often wondered why prices fluctuate as they do. I read a lot and in the next lesson I’m going to share with you a story named “The Parable of Uncle Joe”. I got permission from the author to include it in this course.

After reading The Parable of Uncle Joe, I’m going to get much more detailed about how to use Volume. So stay with me.

The Parable of Uncle Joe

I love to read and study and recently I came across a book on Amazon that I think is one of the best books I've ever read. It's called a Complete Guide to Volume Price Analysis by Anna Coulling from London. She has allowed me to include part of it in this course. It's entitled "The Parable of Uncle Joe" and it's the best analogy I've ever read on why prices rise or fall. I have added a link to her book at the bottom of this page. Enjoy!

Here is her article:

This is the article I wrote for Stocks and Commodities magazine many years ago. I called it the Parable of Uncle Joe. I have made some minor changes, but the essence of the article remains, as originally published.

One day after a particularly bad trading day, my Uncle Joe took me aside and consoled me with some hard facts about how the markets really work. And he told me this story.

You see, my Uncle Joe owns a unique company, which has given him an insider's perspective on how stock price movement is managed.

His company, Widgets & Co., is the only company in the state that distributes widgets, and it does so under license from the government. It has been buying and selling its unique widgets for many years. These widgets have an intrinsic value, they never break, and the number in circulation at any one time is much the same.

Being a reasonably clever man with many years of experience managing his business, my uncle soon realized that just buying and selling his widgets to customers was, in fact, rather dull. The amount of money he made each time he bought and sold was quite small, and the number of transactions per day was also low. In addition, he also had all the running expenses of his office, his warehouse, and his staff. Something would have to be done.

Having given the problem some thought, he wondered what would happen if he mentioned to a neighbour that widgets could soon be in short supply. He knew his neighbour was a terrible gossip, so this was almost as effective as putting an advertisement in the local paper. He also knew from checking his warehouse, that he had enough stock to meet any increased demand should his plan be successful.

The following day he met his neighbour outside, and casually mentioned his concerns, begging the man to keep it to himself. His neighbour assured him that he wouldn't breathe a word; his lips were sealed.

Several days passed and widget sales remained flat.

However, after a week or so, sales started to pick up with more customers coming to the warehouse and buying in larger quantities. It seemed his plan was starting to work and everyone was happy. His customers were happy as they knew that widgets would soon be in short supply, and so their value would increase. Uncle Joe was happy because he was selling more widgets, and making more money every day.

Then he started to think.

With everyone buying his widgets, what would happen if he raised his prices? After all, he was the only supplier and demand was high at the moment.

With everyone buying his widgets, what would happen if he raised his prices? After all, he was the only supplier and demand was high at the moment. The following day he announced a price increase, but still believing there would soon be a widget shortage, his customers continued to buy in ever larger quantities!

As the weeks passed he gradually increased his prices higher and higher, but still, the buying continued. A few of his more astute customers started to sell their widgets back to him, taking their profits, but Uncle Joe didn't mind as he still had plenty of willing buyers.

This was all good news for Uncle Joe, until one day, he suddenly realized with some alarm that his warehouse was now looking very empty indeed. He also started to notice that the volume of sales each day was decreasing. He decided to keep moving prices up, so everyone would think that the situation was unchanged.

But now he had a new problem. His original plan had been too successful. How on earth was he going to persuade all his customers to sell widgets back to him, so that he could continue in business?

He pondered this problem for several days with no clear solution. Then, quite by chance, he met his neighbour again in town. The man drew him to one side and inquired whether the rumour he had heard was true? Inquiring into what that rumour might be, Uncle Joe learned that his neighbour had heard that another, much bigger widget distribution company was setting up a business in the area.

Being clever, Uncle Joe realized that providence had given him the answer on a plate. Appearing crestfallen, he admitted that the rumour was true and that his business would suffer badly. More importantly, widget values were likely to drop dramatically in price.

As they parted company, Uncle Joe chuckled to himself at having such good fortune, and such a helpful gossip for a neighbour.

Within days he had queues of customers outside his warehouse doors, begging him to buy back their widgets. With so many people selling, he dropped his prices quickly, making people even more desperate to sell before their widgets became worthless!

As the prices fell further, more and more people cracked under the pressure. Uncle Joe was now buying back an enormous volume of widgets. After several weeks the panic selling was over, as few people had been brave enough to hold out under the pressure.

Uncle Joe could now start to sell widgets again at their old levels from his warehouse full of stock. He didn't mind if it was quiet for a few months, as he has made a great deal of money very quickly. He could afford to take it easy. His overhead expenses were covered and he could even pay his staff a healthy bonus. Everyone soon forgot how or where the rumors had started and life returned to normal.

Normal that is until Uncle Joe started thinking one day. I wonder if we could do that again?

Uncle Joe's story is of course fiction.

It was written before I discovered the work of Richard Ney, but it is interesting we both use the same analogy to describe the insiders, the specialists, or what most people call the market makers.