Volume Trend Breakout Strategy

The volume trend shows whether a price trend is healthy. Both trend types must be in harmony. Only then will a trend be sustainable. Therefore, pay attention to the volume trend and your profits will expand.

Probably many stock exchange traders cannot do anything with the term “volume trend”. Essentially it is about the price movement and the corresponding volume spent. The trading volume corresponds in the figurative sense, the effort required to move the price up or down.

By analysing the volume trend, it is possible to check the quality of the price trend.

Every upward trend is driven by an overhang of people willing to buy, who accept continuously higher prices. Conversely, in the case of a downward trend, it is the market participants who are willing to sell, the majority of whom feel forced to sell.

The market moves within a trend in rhythmic movements. The results of an uptrend are more frequent new highs and higher lows.

The upper picture shows the trend channel of an uptrend. The volume trend is about the same wave movements, only with the difference that the trading volume is in focus. If price trend and volume trend show the same patterns, the trend will continue permanently.

How the volume trend works

Since the pure number of trading volume cannot, of course, give a direction, we have to make the link to the price for an analysis. The simplest and best-known solution is the On-Balance Volume Indicator (OBV). In principle, the trading volume is cumulated with OBV. It is added up if the closing price is higher than the previous candlestick. Appropriately, the volume is subtracted if the current closing price is lower. A simple but effective principle to link price and volume.

The OBV is a relatively old indicator from the 1960s. However, the decades have not diminished the indicator’s effectiveness. It is still as effective as on the first day.

How high may the volume be?

When we talk about an above-average volume, this should not be seen as a law. Trading volume is closely related to the emotions of market participants. If, on average, more volume can be found in the upward direction in a price trend, this indicates a strong buying interest. However, if the volume is weaker, there is no need for a trend to end. Weaker trading volume also occurs when the market is uncertain or when important economic news is expected. As a rule, uncertainty does not lead to a reversal, but to “confused” actions by market participants. Technical false signals are not unusual in uncertain times. However, as soon as the situation has calmed down, the market resumes the trend.

In simple terms, one could say that a price wave continues if the trading volume is above average. However, an extremely high trading volume is not conducive to a trend. Volume peaks contain the characteristic of short-term exhaustion. It is therefore not unusual for a movement with volume peaks to stop. This is followed by a pause, during which market participants reorient themselves.

Advantages with the volume trend

Working with volume analysis must be worthwhile. If you estimate the power of a price movement, it should also be an advantage in practical trading. Such an advantage would be, for example, that a healthy volume trend breaks light resistance in an upward trend. After all, a trend does not run like a straight line. Up and down movements follow their own cyclical rhythm. Three large steps forward and two small ones back are not unusual. Within an uptrend this results in a regular new high. A new breakout above the previous high belongs to it. And if the price trend and the volume trend are in harmony, then the breakouts are particularly easy to achieve.

The volume trend harmonizes with the fundamental analysis

William F. Eng published an interesting discovery in 1988 in his book “Technical Analysis of Stocks, Options and Futures”. He found a close relationship between the OBV indicator and fundamental analysis. He made a rough division of the stock market into smart money and general public. In concrete terms, this involves institutional market participants who have insider knowledge about the companies and are one step ahead of the other market participants. His discovery was that OBV is ahead of the fundamental indicators. Those who follow OBV act in accordance with smart money. Which in turn brings advantages through the insider knowledge of the smart moneys. The OBV trend (here a synonym for the volume trend) shows whether or not a share is collected by institutional market participants in the long term.

It is not uncommon for there to be phases of a sideways market. During this time there are no new highs or lows in OBV. It is a time of doubt. During this phase one should look for new OBV outbreaks. They are often the harbingers of future price direction, because the smart money is involved in the security.

A practical example for the analysis of the volume trend

The implementation is relatively simple. All we need is a price chart and a volume indicator. In our example it is the OBV.

The upper picture shows the TecDAX index with its OBV. A simple moving average of 100 periods (GDL100) has also been inserted. However, the period length is not important. Any length can be selected for the analysis. It would be important that the period length is identical in both the price chart and the OBV indicator.

For the analysis one can then look at the GDL overlaps, both in the price chart and in the OBV. In the chart, three examples are marked in gray.
In the first case you can see that the OBV penetrates the GDL100 more dynamically compared to the price chart. The price follows the volume somewhat later. This is in accordance with the rules, because the volume runs ahead of the price most of the time.

In the second example, we again have a leading OBV. While the price is below the GDL100, the OBV is a prime example of bullish divergence. Obviously the sellers have lost interest and have stopped the large sales. The effect is bullish. The OBV remains above its GDL100.

The third example shows a bit of the pitfalls of technical analysis. The OBV breaks through the GDL100 line with a strong movement. This seems bearish at first sight. The following short term course then remains remarkable. The OBV fights itself fast back into the area above the GDL100. Completely differently the course of the course moves. The price remains short term below the GDL100. The effect is a new and fast bullish divergence. What looked bearish before becomes bullish a short time later.

Study the market forces

A good volume analysis is the study of market forces. Which side has the greatest traction? And at this point, the trader must have the courage to make a decision to go with the strong side. There are critical points in every trend. At these “key points” it seems that a light spring is enough to send the price up and down. In most cases, the market is oriented towards the volume trend. A trader who can focus on such key points has a lot to gain and little to lose.

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