Turn up the volume for profits

If you're using charts to trade the markets, price action is obviously more important than any other factor. The price's direction and the strength of its movement will determine the most critical issue of all: whether you should be buying or shorting. But while price action should be your primary concern, there are other things you need to watch too, such as volume.

The principle here is simple. The most genuine price trends are those that are generated by heavy trading activity. If lots of shares are changing hands, it suggests that lots of big, institutional investors are participating, and therefore the move is more likely to be sustainable. By contrast, a move that occurs on light volumes probably lacks professional money behind it, and is therefore more at risk of coming unstuck.

One approach to trading that is based on this insight is Volume Spread Analysis (VSA). VSA involves looking for a big difference between high and low prices for a particular time period, combined with a large increase in volume. According to Nick Ridley, a stockbroker with Walker Crips Weddle Beck and a specialist VSA trader (www.tradeguider.com), understanding this relationship between price and volume enables to detect turning-points in the market and give you an edge over other traders.

"What we need to consider in VSA is just relative volume," says Mr Ridley. "The relativity is based on whatever timeframe you're trading. If you're trading on a daily timeframe, you should look for big volume increases compared to volumes on the last 30 to 50 days. If you're trading off hourly charts, you should refer to the last 30 to 50 trading hours."

BAT's smoky volume figures

My own studies on volume on the New York Stock Exchange over time have shown that the amount of stock changing hands can be a helpful indicator. However, volume has become a more complicated affair over recent years. To see why, consider volume for British American Tobacco (BAT), the giant cigarette maker and FTSE 100 member.

According to ShareScope, the most popular investment software package among IC readers, volumes in BAT were 3,603,163 for Friday 4 May. This is broadly similar to the figure quoted by Yahoo! finance, which is free, as well as that for the London Stock Exchange's own website. However, this widely quoted number is anything but the full story when it comes to BAT's shares. A further 2,537,880 shares were traded on Chi-X, BATS Europe and Turquoise, which are alternative trading platforms for LSE stocks (the latter is actually owned by the LSE). And yet another 2,915,689 was traded in various off-exchange transactions.

I only know this, however, because I have access to a Bloomberg terminal, which gives a breakdown of this data. But Bloomberg costs around $20,000 per year, so is well out of reach of the average private investor. It may be that this information is available for free somewhere on the internet, but I certainly can't find it!

Still, it could be that the freely available LSE data is adequate for judging what's happening in the markets. For this to hold true, the split in volumes between the various trading venues would need to remain at similar levels over time. In fact, the split for BAT's volume seems pretty volatile, at a glance. However, we may still be able to trade successfully based on big increases in relative volume using LSE figures alone. I am running further tests here and will report back.

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