Market force: the power of volume wave analysis

Is it possible to determine the force of the market? and if we could, would we be able to determine entries based off this information? The market can only ever be in three stages - trending up, trending down or consolidating. The balance of power between Buyers and Sellers is what cause these stages to occur. If we see demand in the market, and buying is overcoming selling, the market will move higher, but if selling is overcoming the buying, the market will fall. If we combine these wave movements with volume we can analyse the force at which they are affecting the market. If the market has demand present and there is good volume behind it, you would expect a good up move to follow - a considerable move in line with the force behind it. However if we were to experience high volume and the up move that followed was weak, would that be a sign that there was some other force restricting that move higher? It is these anomalies than can provide excellent set-ups in the markets.


The chart below is the ASX 200 over the last eight months. I have analysed the wave formations and the force behind them. The chart shows the length of the wave and the accumulative volume for each wave movement. The parameter I have used is 50 points for a reversal wave to be created. The waves are created off the close of the daily price. Therefore a reversal wave is created once there is a close of more than 50 points in the opposite direction.



If we break the chart up into 4 major areas, we can determine if there was opportunity to profit from the analysis of the wave volume. The chart below shows an area in March/April where price had been consolidating before breaking higher.  The market had sold off heavily in March with volume of 9245 (all counts are in millions) with an expected wave length. The market rallied on 3941 and this was the first sign of demand returning back to the market. In five sessions the price had rallied back to previous resistance in comparison to seven it had taken to fall that far. The next two down waves of 1451 and 1050 in comparison to 9245 were very weak and were evidence supply had dried up. The expansion of volume and spread off the low after the down wave of 1050 showed demand was now overcoming supply and price rallied.

The chart below illustrates perfectly how when opposing forces are strong enough, the up move can be halted and reversed dramatically in the opposite direction. If we look at the two up waves in question we notice the first wave is a nice strong move on volume of 4602, with nice demand out of the re-accumulation area below it. However the weakness is evident when we see the strength of the second wave with more volume (4681) yet less than half of the upward move of the first. The market barely makes new highs even with more force than the first move. This is a shortening of the thrust and is a clear sign institutions are selling into the up move and not participating, or not prepared to support it higher. As the market falls off we take out support levels on increased spread and volume. The market continues to fall before we see demand at the 4700 level, and an overall down move of over 500 points, which would have resulted in a great short trade.

The next chart below exhibits an example of selling exhaustion and how the market fails to fall further on the next wave after an extended down move. We note that the market has seen an extensive fall on volume of 16905, followed by a minor rally of 2879. The next wave down is less than a quarter of volume (3928) and we see a false break of the previous low and there is no follow through lower. This is a clear sign that selling exhaustion has taken place. The next rally higher is on 1548 and it seems the market will not push higher until the supply is completely dried up. We notice another wave lower on less volume (1459), followed by a second of 683. The market is churning sideways but the wave volume is indicating a higher move is probable, as the balance has now shifted to buyers. We see the price is then marked up, takes out the previous highs on expanding volume and range - demand on the right hand side of the trading range, and the up trend is established.

We observe in the chart below that the accumulation did lead to a nice mark up of price and a very good area to have bought. The first leg up produced volume of 13166 and a great forceful up move. There was a pullback of only 1710, before leg two (2601) completed. The interesting point here is the next pullback (4887) was one of the highest volumes on the chart apart from the major moves. This may suggest the sentiment could be changing and possible first clue of a reversal. There have been three up moves of 2601,2069,3026 and the thrust has certainly been diminished since the initial up move. It is interesting that the pullback of 4887 did not lead to lower lows and was quite a small wave, suggesting there could have been some hidden accumulation. This could also be the case of trying to offload stock at higher prices, as the up moves that followed have been quite weak. We are currently on a down leg and this may well be the defining leg, and we must consider that the price will need to break lower through the demand line (as it is currently being supported), and to take out the reaction low at 5064 (where demand stepped in to make new highs).

Volume and spread can offer a great analysis of what is happening day to day within a stock and its movements. The added tool of calculating the force of each wave can give a great insight into the balance of power between buyers and sellers. There are forces that exist within the market each and every day and as shown, if you are patient and wait for the market to show its hand, you can profit from the anomalies in the laws of effort versus result through volume wave analysis.

By Mathew McCullagh.