Using Volume Signals to the Fullest

05/17/2012 1:00 pm EST

Focus: TOOLS

Mark Stone

Trading Strategist, Invest To Success, LLC

While many traders focus mainly on price action, Mark Stone explains that volume analysis can help clearly identify important support and resistance areas in any market or time frame.

My guest today is Mark Stone, and Mark, you use volume to trade the S&P futures, but the principles you teach could be applied to any market. Are there two real key points you try to get across that can help traders in whatever market they trade? 

Absolutely. The first one is that a lot of times, we're taught to trade by specific indicators, and when I started, I was taught this way, too. We're taught just to look at an indicator and get in. "Here's where you get in, here's where you get out, here's where you put your stop," and a lot of traders don't understand why.

They will get in based on their psychology and what they think might happen, and they either manage that trade to a loss or to a profit. In my experience, when you understand the convictions and the weaknesses of buyers and sellers and you understand where they're going to get in and out of the market by looking at volume, you can be a trader that has consistent success.

The second principle is that people get into the market to make money, right? You don't get into the market to lose. Most traders get in to make money, and my trade, your trade, or anybody's trade, it really means absolutely nothing to the market because there's so much volume.

What people need to understand is when you place your trade, it doesn't matter to the market. The only thing that is going to drive the success or failure of that trade is all the other trades that come in behind it.

So all those traders and participants who are sitting on the sidelines, when you start to understand the convictions, the weaknesses of buyers and sellers in the current market you're trading in, you have an advantage.

You can start to see through volume where buyers are going to start to come in the market because they see an opportunity for profit higher, and where sellers are likely to step in if price is moving up because they see value lower.

When you start to understand those things, you can start to understand the market principles, so you can add any indicator at that point and understand why your trade is either going to work, or why it's not going to work, and then how to take that trade to maximum profit or minimize your loss.

If you see that volume isn't indicating a value area, and then you're looking for a volume trigger to signal sellers are gone and buyers are starting to pick up, can you quantify the difference there to determine what kind of stop you're using, or you use a stop based on just a technical level?

That's a great question, and this is what helps minimize loss and maximize gain. It sounds cliche, but it's true, because as price is moving towards an area where buyers and sellers typically don't want to do business—a lower-volume area—I can start to see the buyers go away. I can start to see the sellers coming into the market, and I can put my trade on at that low-volume area. 

If, for some reason, the buyers step in and they push price through that low-volume area, I'm out. I don't have to spend two points or two dollars, or one.

I know that the only way they can push it through that low-volume area is with enough volume to overtake the sellers at that point, and I'll see it. I'll see the volume spike in the market and know we have aggressive buyers and they're going to push price up to the next high-volume area.  I don't have to guess; I just get out of the trade and I can take a minimal loss.

Now, on the other side of that, when I start to see sellers step in the market at that low-volume area and I put my trade on at the low-volume area, I know sellers are going to take price down to the next high-volume area where the market agrees is the most accepted price.

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