A Handbook of Technical Analysis: The Practitioner's Comprehensive Guide to Technical Analysis

CHAPTER 6

Volume and Open Interest

LEARNING OBJECTIVES

After studying this chapter, you should be able to:

• Understand the significance of volume action and its implications for market action
• Recognize the early indications of potential trend weakness via volume and open interest divergence
• Identify bullish and bearish signals on volume and open interest indicators
• Forecast potential reversals and corrections in the market via volume cycles
• Set up effective volume filtering for more efficient timing of entries and exits
• Read volume across successive contract months in the futures markets

Although price is regarded as the best indicator of potential future price behavior, volume and open interest offer additional evidence to corroborate bullish or bearish setups. Volume and open interest can indicate potential underlying weakness and also function as timing indicators for potential breakouts. Many novices misread declining volume as a weakness in a consolidation. The relationship between volume with bar range also offers critical insights into the actions of buyers and sellers, especially when extremely low or high volume is accompanied by unusually large or narrow bar ranges, respectively. Mastery over the interpretation of volume and open interest action is of paramount importance to the art and science of forecasting potential price activity in the markets.

6.1 THE MECHANICS OF VOLUME ACTION

Dow Theory of Volume Confirmation

We learned in Chapter 2 that under the tenets ...