High Volume Waves: Trade Market Tops with Confidence

Some journalists and reporters assume that when the market hits new highs on high volume, it is a continuation of the up-move, but this is a dangerous assumption. High volume alone isn’t a reliable indicator of a market rally. Sudden high volume during an up-day may indicate a potential end to the rally if the market falls or moves sideways the next day. The principle of effort versus results explains that if there is increased effort to push prices up, then prices should rise, but if they don’t, something is wrong. This is known as Effort vs Result.

If there is a high volume up-day that reaches new highs but the next day prices remain level or go down, it suggests weakness in the market. This is because if there was professional buying, prices should have continued to rise. The buying may have come from weak holders who are being drawn into a rally top, which is a common occurrence.

a rally fails on very high volume
A rally fails on very high volume (Chart courtesy of TradeGuider)

Effort Vs Result With High Volume

The effort to push prices up is typically seen as a widespread up-bar with increased volume and closing on the highs, which is considered bullish. High volume on up-bars can indicate the presence of supply, which is generally not favorable for the market.

A widespread down-bar with increased volume and closing on the lows is bearish and represents an effort to push prices down. Interpreting bars requires common sense: the effort to move should result in either positive or negative outcomes. In the chart below, an effort to push prices up through resistance was successful, indicating professional investors not selling.

pushing up through supply
Pushing up through supply (Chart courtesy of TradeGuider)

High volume and wide spreads upwards not resulting in higher prices suggest more selling than buying in the market. High volume and wide spreads upwards with no increase in price imply more selling than buying, leading to slowed or stopped upward trend and weakness in the market. This weakness is not temporary and will have an impact on the market for a while.

After High Volume, the Market Needs to Rest

After any high volume up-days, markets often need to rest and move sideways as the selling needs to disappear before further up-moves can occur. Selling creates resistance to higher prices. Professional traders can test the market to determine if selling has disappeared by driving the market down during the day and observing if the activity and volume are low. If so, they know that the selling has dried up, making it a strong buy signal for them.

When a bullish rally experiences sudden high volume, it is not always an indication of strength. If the market is weak, it will be reluctant to go up despite the high activity. In analyzing the market, it’s important to see things in context and base analysis on effort versus results. This approach detaches one from outside influences such as inaccurate news. Markets move because of professional accumulation or distribution. The news may act as a catalyst for a move, but it’s the activity of smart money that provides the effort and the result for sustained price movement.

The Path of Least Resistance

The following points represent the path of least resistance:

  • If selling has decreased on any down-move, the market will then want to go up (no selling pressure)
  • If buying has decreased on any up-move, the market will want to fall (no demand),

Both these points represent the path of least resistance.

  • It takes an increase in buying, on up-days (or bars), to force the market up.
  • It takes an increase in selling, on down days (or bars), to force the market down.
  • No selling pressure (no supply) indicates that there is not an increase in selling on any down-move.
  • No demand (no buying), shows that there is little buying on any up-move.

Bull moves last longer than bear moves due to traders taking profits which creates resistance to up-moves. A bear market cannot develop until the stock bought at lows has been sold. Resistance in a bull move is selling and professionals do not like to keep buying into resistance. Taking the path of least resistance may involve gap-ups, shake-outs, tests, or doing nothing and allowing the market to drift.

Bear markets run faster than bull markets because they lack support from major players. Traders often refuse to sell during bear markets in hopes of a recovery. Locked-in weak holders will eventually be shaken out on the lows as a result of this.

Happy Trading!

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