Use market volume data to determine the bottom

Price and volume constitute the cornerstone of the market structure, forming an endless uptrend, downtrend, top and bottom in all time frames. The interaction between these structural elements will produce convergence and divergence, enabling the keen trader to predict the direction, relative strength and persistence of the market turn.

The price-volume relationship is particularly useful when determining bottoms, because profits can peak when a long position can be entered at or near the lowest low in a downtrend. The volume-focused trader did not catch the falling knife, but acted as soon as possible based on technical signs that indicate that loyal buyers are returning to the once sluggish securities​​.

Key points

  • Price and volume are key tools to identify the bottom and top of the market.
  • When using volume in a downtrend, it is important to look at the downtrend at a specific time interval to understand how it adapts to a bottoming scenario.
  • Two key methods for finding transaction volume involve viewing transaction volume histograms and balance transaction volume (OBV).
  • However, it is still difficult to call the market bottom with absolute certainty.

Reading volume in a downward trend

To read the volume in a downtrend, check the downtrend periodically to see how it adapts to the bottoming scenario. Focus on measuring the coincident trading volume activities of buyers and sellers in balance, throwing out any ambiguous signals. Divergence is useful in this process, especially when looking for hidden buying interest that is not reflected in current price activity.

Directional pressure can be easily assessed during most stages of a downtrend, because volume indicators will show that sellers are overwhelming buyers, or the opposite of what is expected at the bottom. In addition to transaction flow, as the downtrend progresses, check the average daily transaction volume, as a bottom is rarely formed before one of the following two events occurs:

  • Securities have experienced a climax of selling, resulting in three to five times the average daily trading volume, usually in multiple trading sessions.
  • Securities enter the dormant phase, and continue to decline while trading volume has dried up, resulting in lower than average daily trading volume, which usually lasts for several weeks or months.

The first situation triggers a buying imbalance, because strong selling pressure reduces the supply of new sellers and gives buyers an advantage, while the second situation shows that sellers have turned to other opportunities to allow value players to begin the process of bottoming. This is counterintuitive, but compared to high-tumble free fall, securities that are falling with low volume usually take longer to show a lasting bottom.

Use volume histogram to find the bottom

The volume histogram at the bottom of most price charts is a good way to identify and confirm the bottom when analyzed correctly. In the first case, the trader looks for a selling climax and produces one or more high-volume rebounds, indicating short covering. This kind of price and volume activity does not imply an immediate bottoming and a new uptrend. Instead, it forms the contour of the bottom, which may take additional weeks or months to complete.

In the second case, a bullish volume shift may be more difficult to find, because the frustrated securities may trade sideways for months before getting the sponsorship needed to enter a new uptrend. New funds usually enter quietly in these patterns, triggering transactions slightly higher than normal purchase days within the long-term trading range. These rises do not trigger a breakout and are often ignored by technicians because they are not prominent on the price chart.

However, the sum of this buying activity establishes a positive feedback loop, causing the price to rise to a significant level of resistance. A large number of breakthroughs usually occur immediately, which shocks chart observers who have not paid attention to the small details. Therefore, observing this quiet accumulation and entering trades at interval resistance levels can generate considerable profits.

Three-year low volume bottoming pattern

Boston Scientific (BSX) broke below the 2008 bear market low in 2010 and entered a bottoming pattern that lasted for more than two years. The weekly trading volume dropped sharply in 2011 and 2012, indicating extreme indifference during the raging bear market. In January 2013, the securities quietly drawn a weekly downward triangle, breaking through the upward trend line and the 50-week exponential moving average (EMA), setting off a new upward trend, showing rapid progress.

In both cases, observe that the price finally rolls in and test the volume at the low point of the downtrend. This is bullish when the test produces low volume and the price is higher than the previous low. In our modern environment, undercuts to new lows are common, but these can still produce reasonable bottoms when trading volumes are properly aligned and prices rebound rapidly, and close back above the previous lows.

Find the bottom of the balance volume (OBV)

Balance Volume (OBV) provides a useful technical tool to measure the durability of potential bottoms. Observe the indicator during the previous lows of the test and look for it to create higher lows. This model can attract widespread attention and encourage wait-and-see participants to open long positions to support the new upward trend.

Bullish volume divergence

It is especially valuable when the price drops below a previous low and OBV remains above that low, indicating a bullish divergence. This is what happened on the Washington International Express (EXPD) chart after the security price fell by more than 8 points in three months. A higher OBV reveals hidden buying interest, before the recovery wave returns to its annual high.

Bottom line

A classic volume pattern is usually formed at the bottom of the market, allowing keen traders to make quick and accurate judgments, allowing them to get started before the crowd discovers a new upward trend.

Remember, it is difficult to determine the bottom of the market with absolute certainty. Use the methods listed here in combination with other techniques to determine whether the stock has bottomed out to minimize risk and potentially make substantial profits.

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