Volume action

Volume refers to the quantity of traded units in a financial security such as a stock, commodity or futures. Many technical analysts rely on it as it is a telling indicator of demand and supply in a traded security.  When the price of a security rises on low volume, it is sign that the move is unsustainable.

How to interpret price volume action?

How to interpret price volume action

Price action Volume action Interpretation
Price of security increases. Volume increases. There is buying pressure in the security caused by a greater number of orders.

 

The price is likely to continue rising in the short term

<IMAGE of price and volume rising>

Price action Volume action Interpretation
Price of security decreases. Volume decreases. Even though the price is falling, it is not necessary that the short term trend is that of decreasing prices.

 

In this scenario, price is decreasing along a decrease in volume. This means that there is no conviction to a short term downtrend.

 

A price reversal to the upside has a high probability of occurring.

<IMAGE of price moving down and volume moving down>

When the price of the security and volume moves together, that is taken to be a bullish sign as in the scenarios above.

Let us examine 2 more scenarios shown below.

Price action Volume action Interpretation
Price of security increases. Volume decreases. There is a lack of demand in the traded security as the price is rising but volume is falling.

 

Divergence has occurred between price and volume.

 

Since there is a lack of demand for the security, there is a high probability of a price reversal to the downside.

<IMAGE of rising price and falling volume>

Price action Volume action Interpretation
Price of security decreases. Volume increases. There is an increased selling pressure as confirmed by the volume increases as price falls.

 

This is  a high probability that the price of the security will continue to fall in the short term.

<IMAGE of price falling with increasing volume>

When volume and price have a trend divergence as in the 2 scenarios above, it is a bearish sign.

Volume spikes

Volume spikes are sudden volume surges in a security after the security has trended for a lengthy period of time. After a lengthy uptrend, if a volume spike occurs, there may be a reversal in the price trend. On the contrary, after a lengthy period of downtrend and a volume spike occurs, the price may reverse to the upside.

How option traders can make use of price-volume action?

Scenario Interpretation Remarks
Price and volume increases. This is a bullish sign. Consider executing bullish option strategies.
Price and volume decreases. This is a bullish sign. Consider executing bullish option strategies. Know that in general, prices are on a general uptrend.
Price increases and volume decreases. Divergence has occurred between volume and price. This is taken to be bearish. Bearish option strategies work best here.
Price decreases and volume increases. Divergence has occurred between price and volume. This is a bearish signal. Prices may continue to fall in the short term. Bearish option strategies work well when price are falling.
Volume spike after a significant uptrend. Price may reverse to the downside. Plan on executing bearish option trading strategies. Option traders can time their entry points with the use of some other indicator.

 

The options trader can also close out any bullish positions in the underlying security.

Volume spike after a significant downtrend Price may reverse to the upside. Once the reversal to the upside has taken place. An options trader can employ bullish option strategies.