One of the problems with reading the volume bar charts directly is the difficulty in doing so. When attempted, it is soon discovered that reading volume bars is quite time consuming, to say the least.
Fortunately, there are other methods of interpreting the volume bars, and many indicators have been created to make it easier to understand what these bars are saying. Basically, there are two types of volume indicators. One involves combining price and volume, and these types of indicators accumulate volume based upon price action. These types of volume indicators include, but are not limited to, the on-balance volume (OBV) indicator, and the accumulation/distribution (A/D) indicator. The other type is called volume oscillator, which also comes in two types. Some volume oscillators are derivatives of the OBV and A/D indicators, while others are derived directly from the volume bars themselves.
While I am not a big fan of the OBV, the A/D, or other indicators that accumulate volume based upon price movement, I do use them from time to time. I am also not a big fan of volume oscillators derived from these types of volume indicators because these types of indicators and oscillators all contain errors. These errors come from trying to separate up volume from down volume based upon total volume and price action. While these approaches are fairly good approximations of what is up volume and what is down volume, they are not completely accurate, and therefore, contain errors.
The only way to create an accurate volume indicator based upon accumulation of up and down volume is to use actual up- and down-volume data obtained from a data feed. Unfortunately, this information is not readily available to traders for all stocks or stock indexes. The main difficulty I have with these types of volume indicators is that from time to time, they will continue to move higher, indicating that volume continues to expand, while at the same time, the actual volume bars are contracting. Despite this inherent error, these types of volume indicators and their derivative oscillators tend to work reasonably well most of the time.
The approach I prefer in analyzing volume is to convert the volume bar chart to a line chart, as shown in the lower panel of Figure 1. Viewing lines instead of bars seems to make it easier on the eyes to decipher the volume peaks, valleys, and when volume is increasing and decreasing. In addition, I add a 200-day simple moving average to represent the average of volume. When the volume line is above the moving average, it tells me volume is expanding, and when the volume line is below the moving average, it tells me volume is contracting.
To help in the analysis of volume and how it helps interpret the price trend, I have shown the daily price bars in green when the volume line is above its 200-day simple moving average, and I have shown the price bars in red when the volume line is below its 200-day simple moving average (see upper panel of Figure 1). When the price bars are green, they tell me that volume is expanding, and when the price bars are red, they tell me that volume is contracting.
In addition, I have also added a volume spike chart to the middle pane of Figure 1. The vertical lines are the daily volume bars. The volume bars above the horizontal line represent days when volume spiked to more than twice the volume compared to the previous day. The volume bars below the horizontal line represent those days when volume decreased by more than half the volume of the previous day. From the volume guidelines, note that volume sometimes spikes upward at the top of an uptrend. This is known as frantic buying and results from greed. Volume also sometimes spikes near the end of a downtrend. This is called panic selling and is a result of fear. These are represented by volume bars above the horizontal line. Volume also sometimes contracts sharply at the end of a downtrend. These volume bars are shown below the horizontal line. Please note, however, that frantic buying and panic selling do not always occur.
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Tickers Mentioned: Tickers: GLD