5 Rules Interpreting Volume Patterns 0 comments

Mar 10, 2015 11:25 PM

Volume Is A Leading Indicator

High Frequency Trading and Dark Pools are a frequent topic in stock news, and many retail traders wonder how they can have an advantage against HFTs. The easiest way to front run the HFTs is to understand the Volume Patterns of the Dark Pools, which precede sudden huge HFT runs and gaps.

There are only 3 pieces of data that come from the stock market for stock indicators and those are Price, Time, and Quantity aka Volume. From those 3 data streams, hundreds of indicators have been written over the past century. Most indicators are based on only Price and Time. With the plethora of new market venues and especially with the rise of Dark Pool Alternative Trading Systems ATS trading, Volume has become an even more important indicator.

Unfortunately, online brokers, retail vendor trading systems, and trading classes promote Price and Time indicators such as MACD, Stochastic, and Bollinger Bands but rarely is Volume explained and why it is so important.

Volume bars are critical to any trading style as they complete the data from the stock transaction. Without Volume, retail traders are hampering their analysis by leaving out a huge aspect of stock chart analysis.

Volume reflects the interest of the various Market Participant Groups, as well as which groups are actively trading the stock. If you know what to look for it is not difficult to see the various footprints of each group on a Candlestick Chart. With 9 Market Participant Groups it is essential to be able to recognize which group is buying or selling, regardless of what price appears to be doing at that time.

Price can be running up and suddenly a huge black candle or run down occurs, with no prior indication on the price chart or Price based indicators. Volume warns of such risks. Learn 5 rules for interpreting Volume Patterns in stock charts.

The analysis of only price using Price and Time indicators without any Volume indicators can lead from inaccurate to severe misinterpretation of price action, the sustainability of the run or trend, and how price will behave in the near term.

Volume reflects many aspects of the trade that Price alone does not reflect, based on the new Market Structure where Dark Pools which are the giant lot transactions are traded off the exchanges. These venerable giant institutions use carefully constructed orders which control price in ways that were never possible when the giant lots were traded on the exchanges. This one fact alone should convince retail traders that they need to spend more time studying and learning Volume Patterns along with Candlestick Patterns.

The relational values between Volume Patterns and Candlestick Patterns provide vast insights into who is controlling price, and whether there are Dark Pool institutions quietly accumulating or quietly distributing the stock WITHOUT moving price. That is the conundrum for all retail traders. If price is not moving but giant lots are buying, which happens all the time in the modern Market Structure, than just using Price indicators will not reveal the most important Market Participants until HFTs move price.

Reading Volume bars is one of the easiest of all indicators to learn and the most critical for beginner retail traders to incorporate into their stock analysis.

Here are 5 rules for interpreting Volume Patterns:

1. Know the difference between High Frequency Trader and Dark Pool Volume Patterns

HFTs create huge sudden explosive Volume spikes, however these are not always accompanied by a huge price move. This is one area that many retail traders miss entirely. Volume spikes are critical to see as they tend to precede a Shift of Sentiment which can alter the trend. When Volume spikes to the top or bottom of the chart window but price doesn’t move, this means that HFTs are battling the Dark Pools and do not know it. Dark Pools always win these battles as they are invisible, whereas the HFTs are on the exchanges. Dark Pool Volume Patterns develop over time, and are very consistent yet also intermittent. To find Dark Pool Volume Patterns, retail traders need to study several weeks of Volume data to find their activity.

1. Never truncate Volume

You want to see the changes to Volume over time. Truncating removes the most important data, HFT action, or other high volume traffic which can trigger Volume Weighted Average Price VWAP orders from smaller funds and retail traders.

1. Use a Sub-ordinate Indicator with Primary Indicators

Using a Sub-ordinate indicator with the Volume bars will make a huge difference in the speed and accuracy of the volume analysis. By establishing extreme low, low, normal, high, and extreme high values for volume it becomes far easier to interpret which Market Participants are moving or NOT moving price at that time. Dark Pool activity is easier to see when a Sub-ordinate indicator is used. HFTs always stand out so long as Volume is not truncated.

1. Understand the Volume Patterns of all Market Participants

Volume Patterns vary distinctly with each Market Participant Group. When retail and smaller lots are buying speculatively and the large lots are allowing these smaller lot buyers to control price, the Volume will start to fade quickly as a stock runs up. Often there will be a negative divergence between Volume and Price. Dark Pools buy into stocks over several weeks to several months acquiring hundreds of thousands to millions of shares of stock. Their goal is always to NOT move price. They establish a buy zone range and then set orders that fire off mostly on quiet or insipid market days when the big popular stocks and indexes are flat or not very active. Dark Pool Volume has a consistency to it that is undeniable and obvious when combined with their Price Patterns. Without Volume, price looks choppy and uninteresting. Traders often miss ideal entries by not recognizing the Dark Pool Volume Patterns early on. Dark Pool activity is chased by HFTs, so using HFT strategies requires that retail traders learn to read the Dark Pool Volume and Price Patterns in combination. MACD will not show these patterns.

1. Learn the Volume Patterns common to various Price Trend Patterns .

Volume also has distinct patterns in bottoms and tops long before the bottom formation is evident, and well ahead of the highest high of the top. This information gives retail traders a decided advantage to being prepared and ready for the correction or bottom velocity runs. With HFTs driving price up or down, Volume at bottoms or at tops is even more important than during trending patterns. Sideways patterns also reveal whether the pattern has hidden strength for a breakout to the upside, or if it is weaker than it may appear with price alone. Again, Price indicators are unable to reveal these kinds of analyses because only Volume can expose who is controlling price.

Summary

When retail traders use Price and Volume together, they are using a complete set of data for their analysis. A complete analysis of all the data available is the standard in all industries where analytics are used. To dismiss Volume as unimportant is to ignore the standard practices of every analytical theory and process.

In today’s market, Volume is far more important than it was in the 20th century. This is due to the massive changes to the Market Structure, in particular the wide variety of trading venues now used and the diverse number of new order types. Volume substantially improves trade analysis which ultimately means higher profitability, and far better consistency in trades.

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Trade Wisely,

Martha Stokes CMT

_{Chartered Market Technician}

Instructor and Developer of TechniTrader Stock & Option Courses

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