Bob Lang: Volume Is Important, But…..

Volume is one of two primary indicators, the other being price action. If you are into technical analysis, the first thing you probably learned is the volume is key. Well, that's partially correct. What is really key is volume levels and volume trends. They are leading indicators in determining market trend and direction.

We will focus on the volume here, because as Jim Cramer says it is 'like a polygraph test'. There is no lying about where the money is flowing. I look at volume prints on a raw and accumulative basis. Strong volume prints (3-5x normal or higher) indicate heavy institutional participation of buying or selling. If the price action confirms this, then we can perhaps see a trend established. We can piggy-back a trade onto the trend.

I look for an accumulation of volume days—a series of low volume prints with higher prices raises a red flag for me. But toss in a strong turnover day with a price breakout and I'm much more likely to dismiss the prior low volume prints.

Let's take a look at a couple of examples with Chipotle Mexican Grill, Inc. CMG and IBM IBM. Chipotle shows a strong volume bar with good price action in January, but the standout was post-earnings in February. That big bar led to a massive move up over time, and that is what we are looking for (also notice the increase in money flow after the next turn higher, shown by the arrow).

As for IBM, the earnings jump in January had spectacular volume, and the stock jumped. But the following move was even more impressive, a solid ABC move into the recent highs. Those were about 10 percent higher than the gap up in January, so there's still time to follow the volume.

Volume won't always be as strong as you like, especially when the markets are near their highest levels. In fact, we often see a lack of volume at these moments, investors preferring to 'sit it out' and wait for the inevitable pullback.

Problem is, the low volume may just indicate a brief pause is happening before the next leg up, so those waiting around are stuck still waiting for that pullback—which may come from much higher prices.