Price and volume are the foundations of market structure, generating an infinite number of uptrends, downtrends, peaks, and bottoms over all time horizons. Interactions between these structural factors produce convergences and divergences, which enable attentive traders to forecast market direction, relative strength or weakness, and market turn durability.
Because profit potential maximizes when long positions can be opened at or around the lowest low in a downtrend, price-volume connections are particularly beneficial in spotting bottoms. Rather than trying to catch a falling knife, the volume-focused trader responds early on technical signals indicating that committed buyers are returning to a once-depressed investment.
- Price and volume are critical indicators for determining market bottoms and peaks.
- When utilizing volume in a downtrend, it is critical to examine the downtrend at certain intervals to see how it matches the bottoming scenario.
- Looking at volume histograms and on balance volume are two important approaches for determining volume (OBV).
- However, calling market bottoms with perfect confidence remains challenging.
Reading Volume In Downtrends
Examine the downtrend at repeated periods to determine how it fits into a bottoming scenario to interpret volume in downtrends. Concentrate on contemporaneous volume activity, which assesses the balance between buyers and sellers and eliminates any confusing signals. Divergences may be helpful in this process, particularly when searching for concealed purchasing interest that isn’t represented in current price action.
Because volume indications indicate sellers overpowering buyers, or the exact reverse of the situation predicted at the bottom, directional pressure may be clearly analyzed during most periods of a downturn. Look at average volume day-to-day as the downtrend proceeds, since bottoms seldom occur unless one of two things happens:
- The security has a climactic sell-off that results in three-to-five times the usual daily volume, frequently spread over many sessions.
- The security enters a slumber period, during which it continues to decrease while volume dries up, resulting in lower-than-average daily volume for weeks or months.
The first situation results in a purchasing imbalance because heavy selling pressure decreases the supply of new sellers, giving buyers an edge, while the second scenario suggests that sellers have moved on to other possibilities, enabling value players to begin the bottom-building process. Contrary to popular belief, a security in a low-volume drop will frequently take longer to reach a stable bottom than one in a catastrophic free-fall.
Finding Bottoms With Volume Histograms
When evaluated properly, volume histograms located at the bottom of most price charts perform a fantastic job of detecting and confirming bottoms. In the first scenario, the trader seeks a selling climax that results in one or more high volume rebounds, indicating short covering. This price and volume behavior does not indicate an impending bottom or a fresh rise. Rather, it creates the contour of a bottom that may take weeks or months to finish.
In the second situation, a positive volume shift may be more difficult to discover since beaten-down shares may drift sideways to lower for months before gaining the sponsorship required to launch a new uptrend. In these patterns, new money typically enters quietly, sparking slightly higher-than-normal buying days inside long-term trading ranges. These upticks do not result in breakouts and are sometimes overlooked by technicians since they do not jump out on the price chart.
However, the aggregate of this purchasing activity creates a positive feedback loop that drives the price up to a significant resistance level. A strong volume breakthrough often follows promptly, surprising chart observers who haven’t paid attention to the finer points. As a consequence, keeping an eye on this calm buildup and placing a trade near range resistance might result in exceptional returns.
Three Year Low VolumeBottoming Pattern
Image by Sabrina Jiang © Investopedia2021
Boston Scientific Corp. (BSX) falls below the bear market low of 2008 in 2010, beginning a two-year bottoming pattern. Weekly volume plummets dramatically in 2011 and 2012, indicating significant disinterest in the midst of a blazing bull market. In January 2013, the security discreetly carves out a weekly descending triangle, breaching the upper trendline and 50-week exponential moving average (EMA), launching a new uptrend with quick pace.
In both cases, keep an eye on the volume when the price eventually rolls over and tests the downtrend bottom. It is bullish when the test produces reduced volume and the price rises above the previous low. Undercuts to new lows are typical in today’s market, but they may still produce real bottoms if volume aligns perfectly and price rebounds swiftly, closing back above the preceding low.
Finding Bottoms With On Balance Volume (OBV)
On balance volume (OBV) is a valuable technical instrument for determining the long-term viability of a prospective bottom. Look for the signal to carve out a higher low during the test of the previous low. This pattern has the potential to attract widespread attention, motivating sidelined investors to build long positions in anticipation of a fresh rally.
Trading a Bullish Volume Divergence
Image by Sabrina Jiang © Investopedia2021
It’s particularly useful when price falls below the previous low and OBV remains above it, indicating a positive divergence. That’s what happened on the chart of Expeditors International of Washington, Inc. (EXPD) when the stock dropped more than eight points in three months. The stronger OBV print suggested concealed purchasing enthusiasm ahead of a rebound to the annual high.
The Bottom Line
Market bottoms often carve out traditional volume patterns, enabling alert traders to make quick and precise predictions, allowing them to get on board before the herd does.
Keep in mind that calling market bottoms with full confidence is tough. To reduce risks and possibly gain a substantial return, use the procedures given below in combination with the other ways for evaluating whether a stock has bottomed.
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