Volume in Trading

1. Volume in Trading Gloria Loew July 7, 2005 Based on Trading on Volume Donald Cassidy 2002

2. Our Objectives • Try to understand trader psychology behind the price moves • Learn implications of volume at different places on a chart • To avoid the psychological mistakes that others make • To determine better entry and exit points • Together develop trading plans based on volume patterns • Do we agree with Cassidy? • Is the trading environment different now? • Can we improve on his ideas? • What other indicators might be helpful? • What else to consider? • Other thoughts?

3. Use Volume Changes to Anticipate Price Changes • People buy and sell stocks • Based on emotions • Caused by perceptions that change with news and rumors • An excited crowd buys enthusiastically and prices go up • A scared crowd sells frantically and prices go down • The size and emotions of the trading crowd is expressed in trading volume • Theme • High/higher volume marks primary price direction • Extremely high/climaxing volume marks reversals • Volume change can be used as a forecasting tool • Changes in volume imply changes in price direction • When the volume action is finished, everyone has already acted and the urgency and momentum are gone • The price move is done and the trend cannot be maintained; prices may be ready to move in the opposite direction

4. Some psychological forces negatively affect our trading decisions • Ego: Feelings of self-worth are attached to our trading activities • Overconfidence: We take credit for success that might not be because of us • Camaraderie: We like to be part of the crowd and own the same successful stocks • Anchoring or Framing: We have a strong tendency to evaluate new information in the context of what we already know • We expect what is/trends to continue • Causes us to sell at bottoms and stay too long at tops • Lulls us into complacency • Cognitive Dissonance: It is difficult to accept new information that is contrary to what we already know • When a negative surprise about a stock leads to price collapse and a long recovery time, people experience pain and might panic or be paralyzed and unable to deal with other stocks also • Denial: We stick our heads in the sand; our ego is affected, we try to avoid pain and guilt

5. Some causes of crowd action that have volume implications • Mutual funds buy on good news • Mutual funds sell on bad news and because of redemptions • Internet investors want to be with the crowd • Investors on margin have to sell • Investors’ reactions to news

6. Volume/Price Relationship • Look for a predominance of bullish or bearish combinations of daily price and volume data rather than a signal from one day • Window should be not too short or too long • Observe infrequent but very strong exceptions • Interpret lighter volume days as countertrends or resting days • Ignore volume prior to earnings and other special situations

7. Two very important volume patterns Crescendos and Spikes • Events that drive these patterns are different • The emotional aftermath is different

8. Volume Crescendo • Occurs over a period of up to five days • A gradual buildup of daily trading volume that accelerates with volume growing as size and excitement of the crowd grows • After several days, everyone knows the story and has gotten in • End of volume is end of momentum behind the price change • First hour or two in a new session almost always reveals whether the crowd is still growing or has already peaked. When the volume is no longer expanding, the move is over. • At the peak of the crescendo, it is ready to reverse gradually • Will take some time to play itself out before trading activity can return to normal levels; latecomers will affect volume even though the price doesn’t go up • This is different from a small increase in volume that will probably continue an existing trend up or down

9. Volume Spike • Spike is sudden and extremely large • Occurs between trading sessions and is single-company specific (except for unpredictable and catastrophic world events) • Usually driven by news since last trading period • Reg FD/fair disclosure will cause more surprises, leading to more volatile stock price behavior, with an increased likelihood of volume spikes • Begins with a single day of huge volume, maybe 5 or 10 times normal • Extremes by definition can’t last

10. Examine 8 Volume Scenarios • Volume Crescendo Breakouts Trend: Flat or congested • Breakout to upside Price will continue up • Breakout to downside Price will continue down • Volume Crescendos That Continue or Accelerate Recent Trend Trend Up Accelerating upside Price will reverse and go down Trend Down Accelerating downward Price will reverse and go up • Volume Crescendos That Reverse Price Direction Trend Up Crescendo down Price will continue down Trend Down Crescendo up Price will continue up • Volume spikes Trend Up Volume spike up Price will reverse Trend Down Volume spike down Price will stay depressed

11. Volume Crescendo Breakouts/Ups Trend: Flat or congested Breakout upside Maybe the beginning of a new trend • Usually news-driven; best if not • Buyers join in • If move was because of news • Ordinary: Volume and move are over quickly; breakout price often fades • Significant: Move will continue • Chart examples • Not news driven: ERS 5/16/05 • News-driven ordinary: • MWD 6/13/05 CEO Purcell leaving; good news • QDEL 2/17/05 reported strong 4Q results; price faded • GOOG 2/2/05 strong sales and earnings; price faded price went down • GOOG 4/22/05 first quarter profit huge; price faded price went up • LM 5/4/05 announced great earnings • LM 6/24/05 deal with Citibank • News-driven significant: • DNA 5/03 (more sig pre-split) Avastin phase III for colon cancer • DNA 2/04 FDA approves Avastin for colon cancer

12. Volume Crescendo Breakouts/Down Trend: Flat or congested Breakout downside Price will continue down • Almost always news-driven • More investors panic and sell • Chart examples • SFD 6/05 on earnings • SJM 6/05

13. Volume Crescendos That Continue or Accelerate Recent Trends/Up Trend: Up Accelerate up Price will reverse and go down • Buying climax • Everyone is bullish, latecomers join in • Price reverses because • An emotional peak • All buyers are in • Urgent signal that price will reverse as soon as volume fails to increase another day • After the run and reversal, resistance at top for a considerable period (unless there is an upside surprise) • New holders have no motivation to hold • Long-term holders wish they had gotten out before the drop • Chart Examples • ADCT 6/05 • HXM 12/04-2/05 • BZH 1/01-2/01, 4/01-5/01 • GOOG 5/05

14. Volume Crescendos That Continue or Accelerate Recent Trends/Down Trend: Down Accelerate down Price will reverse and go up • Selling climax • Might be caused by more negative news or market washout • Can last for a longer time than up crescendo because fear is a strong emotion and panic sets in; can have huge price drops or fall of its own weight if no buyers • Waterfall frenzy with increased volume and decreasing price that accelerates; creates severe panic after the stock has already been declining • Price reverses because • No more sellers • Panickers are exhausted or too numb to act • Margin calls are finished • Low prices bring out the bargain hunters • Price might rise sharply at first then more slowly • Chart examples • RELL 6/05 • SAP 4/05 • RGS 4/05 • BDX 6/05 • HC 5/05 blow-off bottom • SY 7/05 reverse with Arms’ Ease of Movement

15. Volume Crescendos That Reverse Price Direction Trend: Up Crescendo down Price will continue down Trend: Down Crescendo up Price will continue up • The beginning of a new move • Enter long and short orders after price breakout and pullback • But maybe there won’t be a pullback • Chart examples • Reversal Down • BAC 6/05 • EXPD 3/05 • FDX 3/05-4/05, 6/05 • Reversal Up • AMLN 6/05 • ARMHY 5/05 • BZH 11/01

16. Volume Spike Up • Gaps up on huge and sudden shifts of investor opinion • Exception: proposed acquisition of a firm; known facts about the firm rather than opinion • Buyers come in all at once • Rest of the day tug of war between buyers and sellers • 2nd day more buyers and short-covering with lower volume, 3rd day lower volume • Prolonged unwinding with lower volume and price, often closing the gap • Will take time to build a base • Strategy: • Sell on 1st day • Can sell short • Chart examples: • OSIP and DNA 4/26/04 lung cancer drug • DNA 4/15/05 breast cancer drug • DNA 4/26/05 breast cancer drug • DNA 3/14/05 breast cancer preliminary result (not a spike) • CBST 6/05 antibiotic drug news • MYL 6/05 financial announcement • NVS 2/05 buying 2 other labs • RL 6/05 earnings • OII 6/05 • NCRX 6/05 • ANDS 6/05 (7/05 parabolic) • BWA 5/05 gap almost closed

17. Volume Spike Down • Fear is a strong motivator, so downside will be strong • Low of day 1 doesn’t hold 70% of time • If held by institutions, drops on earnings will be more severe • If selloff for several days will build a lengthy base • Higher fliers will fall harder • Many people have been hurt; stock will not recover soon • Strategy • Sell immediately • If not sold right away, wait about a week and sell into any rallies after 2 or 3 days • Don’t get in again until bottom holds and volume returns to normal • Exception: a market crash when everything falls, the stock is not implicated and so can be bought • Chart examples • MRK 9/04 • BIIB 2/05 • CATT 4/05 • NVS 4/05 foreign stock

18. Additional Charts to View and Discuss • PRAI 6/05 June reversal/candle • BF, RD, RTP foreign stocks have a lot of gaps • CVX 3/05 – 5/05; 4/05 volume middle of the move • EAGL 3/05, 5/05; more complicated; began and ended with big volume • EDMC 5/05 • GOOG spring 05 sometimes volume shows up better on weekly chart • PKZ 3/05 – 5/05, weekly chart emphasizes volume, also candle early May • IIJI 5/13/05 revenue announcement; 6/05 determined offering price for shares in Tokyo…or was it just too high? • MMM 4/05, then basing pattern, then 6/05…??? • MXT 6/05 and 7/05 • MYL 5/05-7/05; also corresponds to sector performance • PLCM 05 several crescendos/spikes down that didn’t have immediate impact on price • POSS 8/04-5/05 three spikes with gaps down; stocks have their own personalities • QDEL 5/05 volume spike and small candle wasn’t meaningful • QDEL 6/05; huge volume with significant candle • QSII 6/05; dueling spikes for a few days • ARMHY 6/05 spike up then waterfall down • SPI 2/05 < vol, 5/05 > vol 2 days • BHP 7/6/05 volume spike, small candle • SINA 2/05 turnaround up, volume displays as down

19. Low Volume and Special Situations • Low volume in existing downtrend might be a sign of the end; prices might go up or build a base • Low volume the last week in December is not an indicator • Whatever happens on low volume last week in December will probably be reversed 1st week in January • Low volume consolidation/corrections also happen intra-day • Tax selling by mutual funds before end of their tax year in October and individuals in December and closed-end funds will not usually mean rising prices

20. Our Thoughts/Improvements • Entering argument should be price; look to be sure demand is exceeding supply • Volume can be used as a confirmation of price patterns • Price can go up without volume; maybe there are no sellers • Never ask why • May be difficult to know what the volume really is because stocks are traded on several markets • Indicators work better on stocks that have smoother patterns • Stikky Stock Charts book says to look at charts in slices of time/trends; what is the volume doing during that period?