Volume Spread Analysis – Spotting the Hidden Clues in Volume

Price action and volume lies at the core of technical analysis, since that is all the data a market technician works with. Almost all technical methods, such as chart patterns, candlestick patterns or even Elliot wave are studies of price action. Indicators like RSI, Stochastics or MACD are all calculated from price data as well. To understand the big picture, it pays to first understand the building blocks.

Volume Spread Analysis - Spotting the Hidden Clues in Volume

Volume Spread Analysis – Spotting the Hidden Clues in Volume

At the most basic level, price action is the movement of a security’s price. This encompasses all technical and classical pattern analysis, including swings, support and resistance, trends, etc. The most commonly known tools are candlestick and price bar patterns, which are ways of cataloging common price action patterns.

However, the crux about price action is not about memorising patterns and names. It is about understanding. That is what professional traders do. No two people will analyze every bit of price action the same way, and that is why a lot of traders find the concept of price action so elusive. That is why it takes experience to read price action.

Below is a useful picture summary of essential candlestick patterns:

Volume is the number of shares or contracts that trade hands from sellers to buyers during a period of time, and serves as a measure of activity. If a buyer of a stock purchases 100 shares from a seller, then the volume for that period increases by 100 shares based on that transaction.

Hence, volume is energy. It represents the level of commitment and participation by buyers and sellers, hence it indirectly indicates the supply/demand equation. Volume at times also serves as a leading indicator, because large movements in the market are due to the actions of market-movers (also known as the professionals or smart money), and these actions will show up in volume and price. At times,either of these two could provide the leading clues to future market movement.

The level of volume marks the significance of events – for example a breakout, a gap movement, or breaking a key support, etc. The higher the volume, the more significant these events are, because it shows more participation by smart money. In general, volume should be rising n the direction of the trend and decreasing on corrections, which would also be useful for identifying pullbacks in a trend. Watch out for unusual climatic moves in volume, for a climax usually results in a swift reversal or rebound.

The key is understanding the relationship between price and volume.

Dow Jones Industrial Average – watch for demand coming in at support zone


Currently, a markdown phase is heading right into a channel bottom area, where potential demand could come in. We should be looking out for signs of accumulation and bullish reversal bars or small pause bars which could turn the tides.

Asia Investment Banking Conference 2009


This event was held in SMU, and saw professionals and student flying in from all over the world to attend talks and networking sessions with a variety of renowed industry speakers. 

After 3 days of talks and workshops, the event culminated in a memorable networking dinner and social drinking session in a professional setting. It was indeed a great opportunity to network with many industry professionals.

The 3 Essential Elements in your Roadmap to Success

Having studied many professional traders, I found that there are 3 crucial factors that have led to their success. All these market wizards have found success because they have understood and mastered the 3Ms of trading – Method, Money and Mindset.

Method (chart-reading): Process by which a trader enters into the market, using either technical or fundamental inputs to make their decision

Money (risk management): This includes capital allocation, risk parameters (drawdown limits), risk-to-reward calculations (entry price, profit target, stoploss)

Mindset (psychology): Market psychology the most important part of trading, and determines how well you can execute your trading plan in the markets in real time

The 3 Essential Elements in your Roadmap to Success - Wrong Allocation!

The 3 Essential Elements in your Roadmap to Success – Wrong Allocation!

To many new traders who know of these 3Ms, they tend to make the mistake of giving equal weightage to all 3 parts (refer to above), or even worse, almost 100% weightage to the “Method”. The most obvious danger is neglect to the other essential parts.

In reality, a professional trader should allocate the 3Ms as depicted below here:

The 3 Essential Elements in your Roadmap to Success - Correct Allocation!

The 3 Essential Elements in your Roadmap to Success – Correct Allocation!

The psychology (mindset) is the hardest part of trading because emotions like greed and fear run wild once your money is at stake in the market. Hence, your degree of rational analysis is only limited to how well you can manage your psychology. Without the execution, the plan is useless. The money and risk management is also essential because it ensures your survival and consistency in the markets. After all, the number one rule is capital preservation.

“Don’t focus on making money; focus on protecting what you have.” – Paul Tudor Jones

Technical Analysis: The Basics of Reading the Market

Technical Analysis is the study of price patterns and trends in the financial markets so as to exploit those patterns. It is in effect applied mass psychology, for it studies the collective action of all market participants. The classical method focuses on analyzing behavioral patterns and patterns, while the statistical method uses formulas and statistics to find mathematical patterns.

Technical Analysis: The Basics of Reading the Market

Technical Analysis: The Basics of Reading the Market

 

In applying technical analysis, the same skills can be applied almost universally across different charts and markets, for example a head and shoulders pattern on a stock chart can be interpreted in a similar way to one one a forex or commodity chart. This is useful if you need an immediate opinion on a market that you know nothing about. The reason technical analysis works so well across different markets universally is because it analyses market psychology, which is the collective psychology of individual market participants.

In contrast with fundamental methods, technical analysis is much less time consuming, for example it can take as little as five minutes to analyse a chart, while doing a valuation on the same stock may take days. This is possible because market technicians believe that market action discounts everything, so instead of trying to figure out the “true” value of a stock by valuation, the technician allows the market to do that for him, by looking at the consensus of all market participants. In addition, technical analysis provides great timing and price projection tools, which cannot be found in the fundamentals.

Technical analysis is part art and part science, which is why both its branches complement each other in analysis. For the classic method, there is some subjectivity involved, since different technicians can interpret the same charts in different ways. In addition, charts cannot be used to predict sudden positive or negative fundamental events, for example earnings, rights issue, M&A. Therefore, it is also importance for technicians to keep track of company news or recent developments, since these act as price catalysts.

Fundamentals and technicals are not mutually exclusive. One way to visualise this relationship is to think of fundamentals as the cause (economic reasons why a stock price moves), and technicals as the effect (the actual moving of the stock price). In the short run, the cause and effect might conflict, and it is almost impossible to attribute the infinite different causes to the observed effects. However, in the long-run, they tend to converge.

Ultimately, investing is a game of probability. Only the insiders in the company know almost everything about the company. For us, who are outsiders, although we may have gathered extensive sources of information on the company, industry, country, we may still be wrong. Thus, it is wise to couple technicals (price consensus of all market participants) with fundamentals (specific knowledge of industry & company) to increase the probability of earning a positive return on your investments.

Technical analysis is used to find opportunities when the probabilities are in your favour, and project possible paths and key levels that prices will reach. It is using past data to make a calculated guess of the future. It is NOT a crystal ball that can forecast the future.