Understanding Volume
the Key to Unlocking Profits - Part 4
by Gail Mercer, Hawkeye Traders | September 2, 2009
PrintIn our previous articles, we have discussed normal volume, abnormal volume, volume spikes and volume patterns that identify potential tops or bottoms. This week we will be discussing more volume patterns that show accumulation and distribution.
Distribution
Distribution is the process of sellers absorbing the buyers in the market, very discreetly so that other traders do not recognize they are distributing their shares. Distribution always begins occurring at the top of bull markets but typically is not recognized until afterwards.
A cursor that the market is going into a distribution phase when prices have been rising in an uptrend and then a buying climax** occurs -- we discussed this last week (after a substantial upward price movement, a wide ranging bar occurs at the top of the market (making a new high, and closes near the top of the price bar with high volume).
Buying Climax
After the buying climax, heavy volume remains in the market, but price are no longer increasing at the same rate. This volume pattern indicates that the buyers are being ABSORBED by the sellers, in other words, there is no longer a demand for higher prices.
Although this exact point may not be the reversal point, you will see price go into consolidation and eventually breaks to the downside because buyers become frustrated and stop trying to increase the price.
The key here is the heavy volume which is not confirmed by price -- BEWARE.
Distribution
Accumulation
At the end of bear markets, accumulation begins -- buyers entering the market and accumulating shares very discreetly so that other traders do not realize they are actually taking long positions. The precursor to the accumulation phase is the opposite of the buying climax -- a selling climax**, which we discussed last week, as well (after prices have been moving downwards, a wide ranging bar with high volume occurs with the price bar closing at the high of the price bar).
Selling Climax
After the selling climax, price will cease to decline at the same rate. This means that price has reached a support area and that buyers are now absorbing the sellers. This normally occurs during a consolidation period, in which the buyers are absorbing the sellers. Sellers become frustrated as they are unable to cause the prices to go down, and eventually an upside breakout will occur.
Accumulation
Again, the key here is the heavy volume which is not confirmed by price -- BEWARE.
A great example of these patterns can be seen in the chart below for Citigroup. In October 2008, there was a wide ranging bar, with high volume and a close up around the high of the bar. This alerted us to a potential of the market going into an Accumulation phase. However, when markets go down, they do so with such force, that it takes a while for them to stop. Nigel calls this the "tanker effect", which is when you have a tanker moving at 65 miles per hour, once he applies his brakes he does not immediately stop. Instead, he continues moving for an additional distance until eventually he stops.
In January 2009, the chart shows a volume spike, which failed to move prices lower. This is our second indication that prices may be reversing in the near future. Thereafter, we see that price fails to move down, moving into a consolidation phase with the buyers are absorbing the sellers in the market. Since the entry criteria has not been met, we simply put the Stock on our Watch list and move on to the next prospect.
**Although the buying or selling climax is considered a pre-cursor to the accumulation or distribution phase, the climax can also come at the beginning or ending of the accumulation or distribution phase, as well.
Copyright © 2009 Gail Mercer
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