When trade volume is low but gains and losses are large, professionals tend to tout a possible turn in market direction; the provincial rule of thumb being that without strong volume, a market move is not valid. Here we look at how to interpret volume and the principles behind doing so.

Simple but Powerful Volume is the indicator chartists monitor to determine whether a move in the markets, a sector or a single issue, has conviction.

It may also be the easiest of all indicators to understand—just add the number of shares traded in a given period to determine the answer. Such simple math requires no weightings or exotic mathematical formulas. It simply indicates enthusiasm or lack thereof for an issue and it has nothing to do with the price.

To confirm a market turnaround or trend reversal, a technical analyst must determine whether the measurements of price and volume momentum agree with each other or not. Disagreement is a sure indicator of weakness in the trend, thus a trend reversal may well be on the horizon. A look at volume from the standpoint of momentum, reveals a recognizable level of buying and selling activity. 

The Oscillator A volume oscillator measures volume by measuring the relationship between two moving averages. 

The volume oscillator indicator calculates a fast and slow volume moving average. The difference between the two (fast volume moving average minus slow volume moving average) is then plotted as a histogram. The fast volume moving average is usually over a period of 14 days or weeks. The slow volume moving average is usually 28 days or weeks. Analysts regularly argue about the applicability of these time periods—some say that 14 and 28 are too conservative, while others argue these numbers are not conservative enough.

Here we use 5/20, as would a short-term trader. The histogram, like an oscillator, fluctuates above and below a zero line. Volume can provide insight into the strength or weakness of a price trend. This indicator plots positive values above the zero line and negative values below the line. A positive value suggests enough market support exists to continue driving price activity in the direction of the current trend. A negative value suggests a lack of support, indicating that prices may become stagnant or reverse.

Interpretation The volume oscillator should rise in a rallying market. When an issue becomes overbought, the oscillator will reverse its direction. When the market declines or moves in a horizontal direction, the volume should contract. 

Always keep in mind that changes in volume are being measured, and volume expands during a sell-off. It is important to note that an increasing price, together with declining volume, is always, without exception, bearish. When the market is at the top, one would, therefore, expect to see an oversold volume chart. Another important point: rising volume, together with declining prices, is also bearish.

A look at the chart of the Dow Jones Industrial Average from Aug. 2001 to Aug. 2002 shows two significant run-ups in the volume oscillator, after equally significant slides. The first is a result of the activity after Sept. 11 and the subsequent market turnaround on Sept 21. The second is a result of fall-off during the summer and a turnaround of over 1,500 points, over the preceding weeks.

For the first case, you can see that volume increased dramatically when the market collapsed on the re-open of the exchanges on Sept. 17, 2001. The Dow then witnessed very low volumes with the rising market, after the bounce on Sept. 21. Volumes were low primarily because investors were still in shock; only the most steely-nerved investors got back in.  

The second case occurs in line with annual summer market conditions where, for the most part, the institutional players are gone for the month of August. Furthermore, the pundits find little excitement, because of a lack of volume when the market moves daily 100 points in either direction.

The Bottom Line This is only one of the many tricks to help gauge market direction in order to further enhance your investments. When it comes down to it, no system is 100% reliable, so regardless of your confidence, remember: it's your money, invest it wisely.

Yahoo FInance. "Dow Jones Industrial Average (^DJI)." Accessed April 2, 2021.