Market Sentiment (Part 3) Volume -
Following the crowd to catch the "bandwagon" effect is one of the best lessons a trader can learn. Another one is "When the wagon is full...be the first one off!"
When everyone is bullish or bearish, it's time to stop following the crowd. Crowds are great until they go to extremes. And there are a number of indicators that can help the technician to recognize when the crowd has reached the extreme!
Ever heard the expression "the trend is your friend"? Let me add something to that. " The END of the trend is your friend too."
A turn in the road is just a turn in the road unless you fail to make it, then it becomes the scene of an accident!
Volume itself is probably one of the most important indicators because it registers trader participation. The raw data alone can be extremely effective, but when we manipulate that data by applying mathmatical formulas and averages, it can be quite powerful.
Market sentiment can be expressed in two words, bullish and bearish. The price of a stock is either going up or down. The harder it runs up and the farther it runs up the more bullish the crowd becomes. The farther it falls off and the sharper it falls off the more bearish the crowd becomes.
A bullish crowd can run the pps (price per share) of a stock up fast and far. A bearish crowd can cause a stock to plummet at a nauseating clip.
The interesting thing is that there is a point at which the crowd realizes that they have gone to extremes, and like a light switch, they turn the other way. That point is called the "PIVOT POINT" or a "reversal point". Sometimes this can take place in one day. In other cases it can occur over a period of days or even weeks.
The problem is that the little light often glows dimly for awhile and most folk aren't even sure if the switch has been flipped. In fact many traders are blind and cannot really tell the difference. They trade by "hearing" only and won't react until many people are talking about the change. One thing is certain, when the crowd has reached the point of extreme emotion it is almost always wrong, and it's time to reverse course!
The market needs certain things in order to move. One of these things is liquidity. More people being involved in a stock brings more liquidity. If people are dis-interested in trading a stock it causes a condition called illiquidity. One of the reasons that trading smaller 'penny' stocks can be difficult is because there are a limited number of players in the game. The more traders involved, the more buyers and sellers willing to exchange funds, the more liquid the stock is.
This is important to the technician because stocks with little liquidity can move erratically. That makes them difficut to trade. What the technician is looking for is a stock with enough liquidity to move the pps strongly in one direction or another as players oscillate between bullish and bearish.
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