Conventional wisdom has it that volume expansion must accompany price expansion in order for the price expansion to succeed, i.e., for the breakout to mature into a trend. But is volume necessary for a successful price breakout? Does price follow volume?
A fish out of water illustrates the necessity of water for fish to live. If there is no water then, then there is no fish (Is water? = False results in Is fish? = False). For us, does Is Volume? = False always mean Is Trend? = False? (Photo courtesy www.goodfreephotos.com).
The Concept of Necessity
I use necessary as in the sense that a fish needs water to survive, so no water (remove a fish from water) means no fish (fish will die). Naturally, in this particular example, there is some time element underlying the statement, because one could pull a fish out of water briefly without it dying.
In a simpler sense, for two events A and B, A is necessary for B, if B is false when A is false. Thus, there is a causal relationship between A and B. So, in this sense, is volume necessary for a successful breakout? Does price follow volume?
A Low Volume Breakout in CBOE Holdings
In Chart 1 I show a low volume breakout in CBOE in late 2016. There was a sharp jump (6.5x the year-to-date average) in volume on a sell-off in mid-September, and volume had declined steadily into year-end. In early December, CBOE broke-out above 71 on relatively "light" volume, certainly less than during the sell-off (only 43%), but greater than the average volume leading up to the September sell-off (about 2.8x). The price then retested the breakout point in a determined dive, again on even lighter volume. Surely, this meant the stock had generated a false breakout. The one relatively large volume day did not produce any significant price movement. From Figure 2, it appears there was little interest in this stock.
Chart 1: CBOE breakout on declining volume followed by a retracement almost back to the breakout point. The volume around the breakout was only about 43% of the volume on the September selloff. The sell-off in September occurred on about 6.5x the average volume in 2016 leading into the sell-off. Do the low volume on breakout and the subsequent retracement imply a false breakout?
Huge Volume Spike on Sell-Off
CBOE continued to make its way higher on low volume, and each new high was quickly turned back. Eventually, there was a very significant volume spike (~26x), well above the September 2016 volume on a sharp retracement from new highs in late February 2017 (see Chart 2). Surely, the trend was over, and the smart money was getting out on very heavy volume.
Chart 2: The massive volume spike on a retracement from new highs in late February surely meant the smart money was taking profits. Notice how the spike volume bar dwarfs all other volume bars in the chart. The volume was about 26x the average volume since the breakout.
CBOE Marches On
CBOE shrugged off the volume spike and continued to move higher, and is now some 30% or more above its break out point. Notice the volume was generally "low" and the few noteworthy spikes were on down days. Clearly, price was not following volume. The weekly chart makes the volume picture a bit clearer. The stock has shrugged off selling surges and moved higher on low or declining volume.
Chart 3: The low volume on breakout and high volume spikes on sell-offs did not slow down CBOE's march higher.
Chart 4: The CBOE weekly chart shows the CTM stayed above 80 throughout the breakout. Surges in selling volume, and low volume on breakout and advances have not hampered the rally. If volume was truly the deciding factor, then the very high (~26x) volume spike in February on a price drop should have pushed prices substantially lower.
Is Volume Necessary for a Successful Breakout?
These are subjective assessments, but I believe price did not follow volume in this example, and volume expansion was not necessary for this price advance. Hence, there is not a causal relationship between volume and price, in the sense of the example of a fish out of water.
One could argue that volume follows price. For example, say you owned a large block of CBOE stock, and you had a $80 profit target. In this case, the stock rising to 80 would cause you to sell your large block, i.e., an example of price bringing forth volume.
If your size was significantly greater than the recent average volume in the stocks, then CBOE would have to be marked down a bit to accommodate your size. The rise in volume in turn might cause day traders to short the stock and generate even more volume. In other words, volume can beget volume.
Alternately, one could argue that price and volume are both random numbers generated by the markets, and though they could be correlated from time to time, correlation is not causation.
(Since this is a historical analysis, I have not included live versions of the charts, since live versions do not provide any additional insight.)
The takeaway is that you are better served by following a price-based indicator such as the CTM to follow trends (see Chart 4).
Thank you for looking in, and let me know if you think volume is necessary for successful trends. In the mean time, please subscribe to my blog by using the link below.