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Volume Clues To Separate The Winners From The Losers

By Greg Kuhn

TradingMarkets.com

It’s utterly amazing how many times I see a technical analyst discuss his/her outlook for a stock based on the stock’s trading pattern alone. These are so-called professionals I’m talking about. In the real world, a stock’s success goes beyond just its trading pattern. The difference between a stock that performs with the market and one that develops into a big winner comes down to volume.

Trading volume in relation to a stock’s price action and how that relationship interacts within a stock’s basing pattern indicates whether a stock is being accumulated or distributed. But it’s the “volume clues,” those days when a stock moves strongly one way or the other within its basing pattern, that can identify which stocks are being heavily accumulated or distributed. Stocks with the heaviest accumulation are the ones in which we want to focus our attention.

Hunting for a volume clue is one way I go about narrowing down my list of prospective buy candidates in a healthy market environment. Big volume on a strong up day is a strong indication that one or more major institutional players are in action. If big, institutional investors, who have a better idea about a company’s prospects than you or I, are accumulating shares within a stock’s basing pattern, that may just be their starting point.

For example, if some large Fidelity fund has already done its homework and has decided to buy 500,000 shares or more over time, the fund is likely to push the stock higher each time. It may build some of its position in the stock’s base, then buy more as it breaks out to new highs and finish off its position into the stock’s fresh, new up trend. Now imagine several large fund managers doing this simultaneously in a hot, new stock in a hot, new industry. This is what’s referred to as “moving into strong hands”.

Let’s take a look at Verticalnet (VERT) as a recent example.

Following the downtrodden portion of its corrective phase from April 22, 1999 through August 11, 1999, Verticalnet began to show several awesome volume clues, with the biggest clue coming a week before its 27-week, cup-with-handle pattern was complete.

“The time to look for a volume clue…is…(when) a stock begins to build the recovery side of its basing pattern.”

The first volume clue occurred on Aug. 13, as it bounced off its correction low. The clue: it was the heaviest volume day within the stock’s entire basing period at that point. Another clue arose two trading days later on Aug. 17 – the second heaviest volume day since the April peak. Verticalnet corrected this initial surge over the next month on considerably lighter volume and held above its correction low to boot. Then, another large increase on volume ensued on Sept. 10, with the stock closing higher, followed by yet another pullback on lighter volume. See the ebb-and-flow developing between volume and price? But the stock has yet to work through its overhead supply within the basing pattern before we even think of buying it. In fact, at this point, the market was acting questionably with no clear signs that a fresh, new up trend was developing in the market – our first line of analysis.

Then it happened. Verticalnet broke above its seven-week congestion zone, the zone containing the initial volume clues, and headed sharply higher for its old highs. But what about volume at this point? Was it tailing off or getting stronger? Not only did it get stronger, volume surged higher than the day before in five of the seven up days between Sep. 29 and Oct. 8, culminating on the final day of the move – a cluster of clues.

It gets better, though.

The stock pulled back over the next six trading sessions on lighter volume again, then surged one more time to complete the cup portion of its basing pattern on Oct. 22. This final surge occurred on the heaviest volume day of the entire basing structure – now there’s a volume clue!

But the pattern is not yet complete. It pulled back one more time into a nice, tight handle. As I watched, I thought, “c’mon volume, be light on this pull back.” There’s nothing like watching a beautiful price-and-volume pattern set up over several months only to watch the stock eventually fall apart. Lo and behold, another move back to the Oct. 22 high and up-and-out-of-there on Nov. 3 – BREAKOUT! I bought Verticalnet breaking above its Oct. 22 close of 62 1/2. The rest is history. Verticalnet was one of the biggest winning stocks during the Nasdaq Composite’s fourth-quarter run, advancing 363% from its breakout spot in 12 weeks.

Verticalnet wasn’t the only stock exuding such volume clues recently. Although it didn’t show as many, Broadcom (BRCM) was under heavy accumulation just days before it popped out of its 16-week base en route to a 120% advance. Note the two, huge volume bars as the stock surged from the bottom of its base back to its old highs around 150 on Oct. 29 and Nov. 1. Verisign (VRSN) was another, as it based for six weeks covering September and October. Volume picked up demonstrably on Oct. 5, 6 and 7, and again on Oct. 21 – all within its basing pattern. This action was a very good tip-off that Verisign was preparing to lead the market if it broke out from its base. It did, rallying 248% from its breakout point at 61 on Oct. 28.

Not every big winning stock will necessarily demonstrate as pronounced a set of volume clues as the above examples. Some will only show a volume clue on one day. Nonetheless, you want to see that one-day volume clue near the top of the base.

Yahoo! (YHOO) was a good example of a stock with a one-day volume clue. On Oct. 7, the stock burst through a two-week consolidation on the heaviest volume day in its seven-month, cup-with-handle base. Following a five-week consolidation, or handle, it was off to a 160% gain from its breakout point on Nov. 8.

And just as a positive volume clue can lead you into a great stock, negative volume clues should lead you away from stocks that may be about to fall out of bed.

Peregrine Systems (PRGN) is one such stock currently under some distribution, as per some recent, negative volume clues. If you just look at its price graph it appears that Peregrine is building a new base – eight weeks so far. However, if you add in the volume histogram, the two largest volume days in the base occurred on down days – not what we’re looking for. This is a stock that is at great risk of dropping out of its basing pattern. That’s not a market call. It’s just that this issue may, at best, only be in the middle of an even bigger basing pattern and needs more time before institutional accumulation arises. In other words, this isn’t a stock we want to key in on at this time.

At the beginning of a leading stock’s correction, it is normal for volume to increase as the stock sells off – especially following a previously strong advance. The time to look for a volume clue, or clues, is following the depths of the corrective stage, as a stock begins to build the recovery side of its basing pattern.

Price without strong volume breeds mediocre, nothing-to-write-home-about, positions. The whole idea is to stuff as many potentially big-winning stocks into your portfolio as possible as the market begins a fresh advance. Searching for a volume clue is an excellent way of narrowing down your list of buy candidates.