Volume is one of the most important indicators traders use to 'predict future price direction. The ability to read volume signals will be one of the handiest tools in your toolbox.

Have you ever gone to a party where few people showed up? Not very exciting, was it? In the same way, when you're buying a stock, you don't want to be the only person at the party! You want lots of people to attend so that the stock skyrockets right out of the gate (breakout).

Think of high volume as energy being directed at a stock. This energy may be positive or negative.

Can you hear your dentist telling you, „Only floss the teeth you want to keep?“ Makes sense. Keeping your teeth extra-clean means they'll stay healthier, longer. When you water and fertilize a plant, it flourishes happily. If you don't, it withers. During the weeks that you deposit money into your checking account, you have the funds to pay your bills. No deposit, no bill paying. Conclusion: Positive energy directed at an entity-huan or otherwise-causes it to flourish. Low or negative energy causes it to stagnate and atrophy.

Stocks, especially, respond to energy. Human energy translates into volume, or the number of shares traded in a specified period of time. By now you've spotted the volume spikes that run along the bottom of the charts we've observed. The spike below the candlestick represents the total number of shares traded during that session.

Here are some general volume rules:

1. Strong volume equals strong conviction, which can be either positive or negative.
2. Low volume equals lack of conviction.
3. Lack of conviction usually means prices will drop.

Now, as swing and position traders, you initially look for high volume on the breakout, when the stock trades over its first resistance area (lots of happy people at the party). As the stock continues to the upside on subsequent days, strong volume (if not quite as strong as the breakout day) is desirable.

When the stock tops off and begins to pull back, or retrace, make sure the pullback is on relatively low volume. Why? Because you don't want the selling pressure (energy) during the pullback to be as strong as it was on the move up. If pullback volume is low, it means that many previous buyers are holding onto their positions. If pullback volume is high, buyers are selling just as hard and fast as they bought. So, the stock will surely drop not only to its previous resistance, but perhaps below it. You don't have to stay at that party! If you are long the stock when it tops out and begins its pullback or retracement, and you see heavy selling pressure coming in via high volume, take profits. The below figure shows ideal breakout and pullback volume patterns.

Attention swing and position traders: The, following volume tip is designed to make you big bucks. When you're scanning charts to find stocks' building bases, look at the volume spikes and locate a stock experiencing increasing volume while the stock continues to trade in the same tight, price range. That particular pattern indicates a strong possibility that institutional buyers are quietly accumulating the stock and hoping no one Will notice. A mutual fund, for instance, might be buying up limited shares per day, so as not to make the price accelerate until the order is filled. Of course, this game can only be played until all the shares offered at the low price levels are absorbed (supply). When that happens, all heck may break loose! If you're tracking the stock like the stealth trader that you are, you'll have your finger on the buy button. In fact, this is one time (as you become more experienced) when you might take on a tiny lot size (50 shares) early on, while the stock is still in the base. You'll set your stop-loss extremely tight (stop-loss settings are discussed in Chapter 11) to keep risk at a minimum. Then, if the stock rockets out of its base, you can add to your position. On the chance that the volume fizzles out and no breakout occurs, you jump out even.

Another volume signal for swing traders: After two to three (or less) days up, if the current day made a new recent high and appears to be ending in a doji, star, or spinning top (short real body) on low volume, it's a good time to take profits. Why? Anyone of those three candlesticks translates into „indecision“ on the part of market players. Remember how low volume means „low conviction“? Indecision plus low conviction equals falling prices. The below figure illustrates this point. The final volume signal for both swing and position traders? When climactic volume designated by a huge volume spikes near the end of an extended uptrend or downtrend, it often indicates the current trend may soon slow or halt. By „huge,“ I mean several times the usual daily volume. If you trip over a mega-spike like this and you're holding a position, take partial or complete profits.

On the chance that the climactic volume reversal warning doesn't play out, and the stock continues in a strong uptrend, you can always buy it back if presented with a good opportunity. (You're better off, though, scanning for a stock ‚that‘s in early stages of an uptrend. The older the uptrend, the less steam it has left.)

Conversely, just because a climactic volume spike forms on a stock that's fallen for several weeks in a pig-ugly downtrend, don't take this as an automatic trend reversal and start bottom fishing. These patterns sometimes take a few days to play out. (Occasionally, they even misfire.) However, if you're convinced the stock is about to tum, you can place the stock on your watch list and monitor it for a future base/breakout.