Combining Volume and Price Information
Financial newspapers provide useful summaries of market activity in the form of a graph. One of the most valuable forms of graphs is one that shows information in comparative form, because in that way you are able to see how two related factors interact over time.
This is the case in overall comparisons between volume and price. For example, The Wall Street Journal reports a daily summary of the Dow Jones Industrial, Transportation, and Utility Averages, and the New York Stock Exchange volume—all for the prior six months. You can see at a glance the direct relationship between the levels of the averages and the volume of shares traded.
These are technical indicators, but they provide valuable information to all investors. As a believer in the fundamentals, you still need to keep in touch with the tone and mood of the market, and if nothing else, technical trends do reveal those features to you. Volume may do more. Besides showing how much immediate interest exists in the market, volume also shows the trading activity taking place. Keep in mind the fact that volume may be on the upside or on the downside. If a day's activity is driven by sellers, then downside volume prevails and prices will be driven downward. If activity is driven by buyers, then upside volume prevails and prices will be moved into higher territory.
Volume trends indicate the general direction of interest in the market. In periods when the market (as measured by the Dow Jones Industrial Average) is rising, volume may increase as well because more people are interested, and want to participate in the positive and, hopefully, profitable times. However, because the averages do not necessarily indicate real strength in the overall market, this is a dangerous tendency. Additionally, high volume might be caused not so much by individuals, but by higher interest among institutional investors. The largest volume of trading activity in the market takes place by institutions, and very little of the actual volume is represented by individuals, also called retail investors.
KEY POINT
Volume is the thermometer of the market. It graphically demonstrates the excitement and enthusiasm—or fear and trepidation— ruling the market at any moment.

Although volume trends are instructive for the market as a whole, at least in gauging the current market mood, they should not be used as indicators for how you should act within your own portfolio. However, keeping an eye on the volume levels for a particular stock will be much more interesting, even when trends do not coincide with the market as a whole. Watching volume, you should concentrate on several tests, such as the following:
Volume changes over time. As it is true with all trends, the test of changes over time is of the greatest significance. Changes in the volume of shares traded could indicate increasing or decreasing demand for the stock. Thus, watching volume trends can be useful for spotting an emerging change in a stock's popularity. A weighted moving average is recommended for following volume trends in individual stocks.
KEY POINT
Watching trends in volume may help you to spot changing perception of a stock, even before that change is reflected in the price.

Volume and price level comparisons. Perhaps of even greater value than merely watching volume is comparing price and volume. This can be achieved by keeping a graph with two separate scales. It is helpful to be able to see changes of both price and volume together, because in some cases the technical trends are related to one another.
An example of a two-scaled graph for tracking price and volume is shown in Figure 9.4.
Volume and price breadth. Another useful technical indicator to watch is the breadth of both volume and price—in other words, the range. The more variation in these two factors, especially when viewed in combination, the less dependable the current indicators. While you will be looking primarily at fundamentals, the wider breadth of volume and price indicates greater than average instability. If a relatively stable volume and price situation begins to emerge, that may also be a sign of changing market perception about the company. This could foreshadow a change in how the stock will be viewed as a long-term growth candidate. For example, if you purchased a stock when volume and price were stable and since then the breadth is expanding, that could be a sign of long-term price weakness.

FIGURE 9.4 Two-Scaled Graph

 

KEY POINT
Stability in a stock's price can be measured by comparisons between volume levels and breadth of price.

A comparative study of volume and price can provide you with early warnings about potential problems with a stock. Even stocks held in high esteem today can fall out of favor tomorrow or in the next decade. If the fundamentals begin to change, thus confirming what market perceptions are already showing, then you might want to make a quick change in your long-term strategy. For example, your plans to hold stock could change suddenly to a sell decision—based on early signs in the technical trends showing up in volume and price, but confirmed by gradual and subtle changes in the fundamentals.