April 13, 2010: It’s never too late to junk old teachings. One key lesson all technical traders learn is that high volume is necessary for prices to rally or drop sharply. In fact the contrary is true. Sharp rallies and drops often take place with decreased volume. Don’t be shocked, we will prove it you, with market data.
Please click here to view the chart with this article
The new lesson here is that price moves the fastest with the least on board. Think of small car and ask the question. Will it move faster with less or more people on board? Less of course.
The logic of the market is simple. Why do prices drop sharply from a certain level? There are no willing buyers or demand at that level. So sellers have to drop prices till they find buyers. Only after they find buyers do prices stabilize. Hence, it’s logical to conclude that from the point of demand loss to the next demand area there will be very little or no buying and selling activity (volume), as there are few or no buyers.
The same principle holds true when there is lack of sellers or supply. Buyers keep increasing prices to find sellers and prices rally sharply with lower volume.
The next question then is what happens when there is a lot of volume. It indicates that there are a lot of willing buyers and sellers, due to which prices don’t have to move much for buyers and sellers to meet their requirements.
Now going into economic-speak, when there are a lot of buyers and sellers at a certain level, prices are at equilibrium. It’s only when number of buyers and sellers are out of balance that prices move reach the next area of equilibrium. So rallies and drops happen when buyers and sellers are out of balance and prices rush to looking for the next area of balance. And during rally or drop phase the volume will be low because price is hunting for the not yet available buyers and sellers.
So the next time a stock market guru tells you that a rally or drop is not valid, due to a lack of volume, just smile and walk away. If you are the debating type you can respond, “the prices rallied because there was low volume.” The guru’s jaw will drop.
Now let us look at market data to prove this theory. Please find below the chart of SPY, the exchange traded fund (ETF) representing the S&P 500. This is one of the largest traded ETF in the world.
The chart is based on volume and each bar represents 10 million shares. Now lets move from the left to the right of the chart. The white lines show high volume areas and the yellow lines show low volume areas. The first white line represents 30 bars or 300 million shares. Notice that prices moved up only 32 cents. Then look at the yellow line right of the white line. Prices moved $1.19 in a span of five bars or 50 million shares. The same phenomenon is repeated with other white and yellow lines.
It’s clear from chart and reasoning above that high volume leads to price stagnation and not sharp rally or drops. The reality is that price moves the fastest with the least on board.
