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Importance of Volume
Price is Everything
Technical analysis is the study of historical price performance in an effort to predict future price performance. Price is the only accurate measure of investor sentiment -- it is the intersection of supply and demand. Investor sentiment is at least and possibly a more important determinant of price than fundamental factors like earnings, revenues and profit margins.
Technical analysis is the study of price and the factors that determine price and thus Fundamental analysis does play a role in shaping investors perception of value. The technical analyst believes that all perceptions of value are encapsulated in one statistic, price.
There are three important principles that govern all technical analysis. First, price is NOT random, second, price anticipates fundamental change and third, the relationship between price and time is linear.
Volume should follow the trend.
In a bullish phase volume should expand on rallies and contract on declines. In a bearish phase volume should expand on declines and contract on rallies.
In an uptrend an increasing number of buyers are required to thwart pent-up and natural selling pressures. The higher a stock moves in price the more likely it is that those that bought the stock at lower prices will want to sell. For the rally to continue these shares need to be absorbed by new buyers. If price advances quickly buyers may step back creating temporary weakness but these periods should be characterized by weak volume if the trend is strong.
In a bearish trend, when the outlook is poor, volume should expand on declines because buyers are overwhelmed by sellers. If the stock sinks quickly some sellers will refuse to sell, choosing to wait for a small rally in price. This temporary absence of sellers creates a small vacuum that should lead to a light volume rally. When the stock rallies sufficiently sellers that failed to exit ahead of the first major decline begin selling and once again volume should expand.
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