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Sunday September 07, 2008 |
Volume in
Trends
From our last section we know that in theory
volume should follow a trend. Once again, this means that in an uptrend
volume should expand on rallies and contract on declines. In a downtrend
volume should expand on declines and contract on rallies. For the purposes of
this section we will assume these rules apply for healthy bullish and bearish
trends.
But what happens when a stock advances and volume
contracts -- or a stock falters and volume expands? It is not supposed to
happen but when it does the result is almost always a sharp reversal.
Rallies With Contracting
Volume
Consider this example. In the winter of
1999 data storage stocks were a momentum investors' dream. The news flow
was positive and analysts were falling over one another to make a name for
themselves by finding the next EMC Corp. (EMC). Atop the momentum mountain
was Qlogic (QLGC).
Qlogic had been mired in a consolidation pattern
through early January and February 2000 before the stock had a volume breakout
at $92. From that point the stock began a parabolic advance that saw the
issue more than double in price in just one month! It was a momentum
investors' dream come true -- there was just one problem, as the stock rallied
to one new high after another amid buy recommendations and better than expected
earnings reports, volume was slowing. In fact, all through the rally,
volume did not approach the high made in early January when the initial
consolidation began. When stocks rally to new highs amid slow or progressively
weak volume technicians argue that they enter the distribution phase -- the
phase where the "smart money" begins selling profitable long positions
amid continued good news. By April 15, just another month later, the stock
had fallen from better than $200 per share to just $60. The weak volume
rally laid the foundation for a spectacular decline. Of course there is a
moral here; Beware weak volume rallies amid good news.
Declines With Expanding Volume
Now let's jump ahead one year. We are still
looking at Qlogic but in the late winter of 2000 the data storage concern was a
very different stock. Ravaged by an ongoing bear market for technology
stocks and a steady stream of earnings warnings, Qlogic shares had fallen from
favor with Wall Street analysts. Those that once forecast fundamental
splendor now talked regularly of impending doom.
In the winter of 2000 Qlogic had fallen far from
favor but the stock did begin the process of consolidating its losses during
January 2001 and early February. The stock rallied from $60 to $98 during
this time frame on better than average volume only to falter once again in the
middle of February after an earnings warning from EMC Corp. (EMC). Qlogic,
and most other data storage issues collapsed and by early April the stock had
fallen to less than $20. It was a short sellers' dream -- there was just
one problem, volume had contracted at each stage of the march to new lows.
When stocks decline to new lows amid slow or progressively weak volume
technicians argue that they enter the accumulation phase -- the phase where the
smart money begins adding new positions for longer term gains. During the
span of the next six weeks Qlogic shares had more than tripled on increased
volume. Of course the lesson is that one needs to be very careful about
selling into weak volume declines amid bad news.
Now that we know what is supposed to happen to
volume in trends (and what happens when reality does not follow theory) let's
take a look at volume in a very different way, consolidations.
the
importance of volume 
volume
in consolidations
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Trends 
