Volume Based Technical Analysis
Volume Analysis before Crash - 2007 year
There are several points worth attention when it comes to the long-term volume analysis.
First of all, one of the main task of volume based technical analysis id to spot abnormal trading activity. On the S&P 500 index volume chart below you may see strong increase in trading volume in the period from the middle of 2006 until the middle of 2007. We had increase in trading volume in 2004 and 2005, however, in 2006-2007 this increase has become quite strong (see point A on the chart below). It could be explained that investors are attracted by the Bullish market and they brought more money into the market. However, when we look at the NYSE Margin Debt chart, we will understand that the money injected in the market in 2006-2007 we mainly borrowed. When you see skyrocketing bullish market it becomes tempting to borrow and buy with expectation that the investment returns will cover the interest paid on borrowed funds. This is not just about regular retail traders, the hedge funds and financial institutions are borrowing from the FED, the banks are using the money of their clients and etc.
The second point that during 2006-2007 we witnessed the number of occurrences when after a strong volume surge to the price up-side we did not had a strong reversal down. In volume analysis a strong Bullish volume surge to the price up-move is called a "Distribution" when a strong wave of the bearish traders invades the market and starts selling high-priced stocks. During the normal Bull market, these waves of the Bearish traders push the market into a correction. This was not the case in 2006-2007. Volume analysis consider it abnormal and it is usually could be noticed at the end of the Bull market, when the market is pumped to extremely overpriced levels and greedy Bulls disregard all fundamental and technical signals.
The third abnormality that could be witnessed on the market is extremely strong bearish volume surges (points B and C on the chart below) and relatively small index reaction.
During 2006-2007, the S&P 500 indexes reacted to any strong bearish volume surge. As soon as the S&P 500 dropped into a correctional move down, egger Bulls jumped in and beat the Bulls - volume surge was seen at the bottom of each correction as the result of such fight. After that, S&P 500 continued its Bullish trend without any trouble. If you scroll our charts back in history, you may see the example of such behavior in June of 2006 and in March of 2007.
In the second half of 2007 we had a radical change in the behavior of traders. In August-September of 2007 we had extremely strong bearish volume surge at the bottom of a correction (see point B on the chart below). As the S&P 500 dropped almost 200 points (more than 10%) it attracted the Bulls and they reversed the market strongly up. However, the Bulls became exhausted very soon. As soon as the index hit the top, the Bears had no trouble to push the S&P 500 index back into bearish trend. We did not see any bullish volume surges (usually sign of a new wave of the Bears). In opposite , we had a drop in trading volume and reversal down - the sign that the Bulls got exhausted and they yield to the Bears.
In November-December of 2007 the S&P 500 suffered another strong correction (see point C on the chart below). Again, we recorded extremely strong Bullish volume surge - again, there were greedy Bulls who massively jumped in by buying at their opining at low. These Bulls reversed the S&P 500 up. However, the same as after the correction in August-September of 2007, as soon as trading volume declined - the Bulls got exhausted and in January the S&P 500 index is back at the bottom for the third time over that past 7 months.
Chart #1: S&P 500, 5-year index volume chart.
The first two points of the discussion above (increase in trading volume and greedy Bullish push up) suggests that in 2006-2007 we had a process of pumping when the market indexes ride up to overbought and overpriced levels on the blind greed of the Bulls. The third point (weak reaction on the extremely strong bearish volume surges) suggests that previously greedy Bulls got either exhausted or they suddenly realized that they have overpriced and overbought stocks in their portfolios. At the end, these Bulls are not willing to push the market higher - they are ready to buy as market declines, yet, they are not willing to continue pushing the market further up. At the same time, strong volume surges (point B and C) reveals that there are a lot of Bears out there - it took a huge volume, a lot of bullish power was put to reverse the S&P 500 index up. There could be not enough Bulls to reverse the market when the S&P 500 drops down for the third time.
Based on these factor, volume analysis points to the strong increase in the number of the Bears. The long-term Bulls became very weak. It may not be the end of the Bull market, yet, the odds of having a much stronger than we had before correction is very high. Such strong change in volume behavior (traders behavior) suggests that we could be looking at 20% at least. If the market go for it, then we have to analyze whether it may grow into a crash and or recession. As of now, volume advise to get out of the market - it is better be safe than sorry.
NEXT: Volume Technical Analysis Tutorial
By V. K. for MarketVolume.com
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