For traders, assessing volume is important to defining the health or weakness of a trend in motion.
Volume should confirm price, meaning volume should rise during up-swings in a bullish uptrend… or else rise during down-swings in a bearish downtrend.
Let’s take a look at recent volume signals in the SPY and QQQ and learn a valuable lesson about volume.
First, let’s start with a prior volume-based chart from April 3rd’s membership report which sets the stage for our current market decline:
In the member reports, I had been highlighting the pattern of Distribution Volume throughout March that was continuing into April.
Let’s step back and define “Distribution Volume:”
After an uptrend, we look for any divergences to reveal a weakness or non-confirmation of price.
When volume DECLINES during rallies in price and INCREASES during down-swings or sell-offs in price, we would refer to this pattern as Distribution which warns of a potential market peak or deeper retracement at a minimum.
Throughout March, we had steadily higher actual prices (in the US Equity indexes) but volume was showing internal or ‘hidden’ weakness.
With the exception of March 14 – 16, we saw a steady pattern of declining volume on rallies which was met with increasing volume/participation on declines/retracements.
I emphasized these with color-codes as shown above – rallies are green and retracements against the prevailing bull trend are red.
Simply compare the progression or slope of volume relative to these rally or retracement phases in price.
The suggestion was one of caution at a minimum (don’t get aggressively long – tighten stops, be protective) or potential to play a reversal that developed with a price breakdown trigger under the rising trendline near $139.50.
Let’s now view an “After” Chart to see the current picture and how price resolved the “Distribution” so far:
After a pullback to the rising lower trendline into $139.50, price stagnated on the support level into the holiday week (where volume in general declined) and then broke sharply lower Monday morning (technically Friday morning after the Jobs Report).
Tuesday’s action was a powerful Trend Day that developed after a breakdown from a larger Distribution Volume Pattern.
You can see the spike in volume that developed on Tuesday’s Trend Day sell-off; this serves as a confirmation of bearish price action and suggests eventual lower prices are possible after an initial retracement.
The volume picture is the same in the NASDAQ’s popular QQQ ETF:
We’re comparing price and volume and the relative movements between them.
To phase the situation in terms of “IF/THEN” statements, we could simplify as the following:
- IF Price rallies AND Volume increases in an uptrend, THEN we would expect the uptrend to continue (we would feel safe in buying retracements).
- IF Price rallies AND Volume decreases in an uptrend, THEN we would be cautious and expect a deeper retracement or price reversal/breakdown.
The recent price activity from March to mid-April provides an excellent example of this classic technical analysis concept.
The reality is that divergences – and distribution volume patterns – can last longer than we’d expect, so we still need to wait for trigger signals from price itself (in the form of breakdowns).
However, it’s important to compare price and volume and using color charts like this can be helpful in assessing the probabilities of a prevailing trend continuing… or breaking down/reversing.
I explain these real-world concepts as they develop on a day-to-day basis with lessons and commentary in each night’s Idealized Trades reports for members which are geared both for educational content like this and discussions for levels/opportunities to watch for the very next trading day or even series of days.