An Important Indicator Confirms Your Trades

| July 28, 2010

Two new yogurt shops open directly across the street from each other. The stores have only been around for a few weeks.  The owners were unaware of the impending competition across the street.  (I know, I know… this is highly unlikely, but I’m trying to make a point!)

One day you get a hankering for some smooth frozen yogurt.  Luckily, you’re right down the street from the yogurt shops.  It’s a hot day and you’re ready for some frozen yogurt delight.

As you arrive, you notice something.  One store has a line out the door. People are waiting to get in…

The other yogurt store is open too, but there are only a few people inside.  You’re stomach’s grumbling and you can’t wait to taste the refreshing creamy yogurt.

So you forgo the busier shop due to the long line.  You waltz right in the nearly vacant yogurt store.

You order up a triple raspberry delight with a twist on top.  Your mouth is watering as it awaits the refreshing treat.  But as the spoon enters your mouth, you notice something.

Your raspberry delight tastes more like brussels sprouts puree…

Your stomach wrenches as you spit the chilled muck back in your cup.  You quickly realize why this new yogurt store is nearly empty… the yogurt is disgusting.

And now it’s obvious to you… the yogurt across the street must be a whole lot tastier.  That’s why there’s a line out the door!

By observing the crowd, you could’ve saved your tongue from a near death experience.

It’s the same with trading…

By watching other investors trade a stock, you can get some very useful clues.  It’s important for technical traders to watch crowd behavior… especially at important support zones.

And this is where volume comes in.

Volume is an indicator measuring the interest in a stock.  In other words, volume shows the amount of crowd participation over a period of time.  The more shares change hands, the higher the volume.  Higher volume at certain price levels can mean more commitment of capital at those levels.

And that’s just what you want to see when you’re putting money to work.  You want commitment to a trade from a large number of market participants.

Let me show you what I mean…

BHI is in the oil services industry.  They do much of the essential support work for oil exploration companies.  With a market cap of nearly $20 billion, they’re one of the big boys.

Take a look at the green line in the chart…

It’s the $36-$35 support zone.  You know it’s an important price area simply by watching the price action and the volume.  Notice how BHI reacted at the $35 level in September of 2009 (the left circles).  Volume jumped significantly.

Remember, high volume means a lot of shares were changing hands. Seeing volume spikes at a support zone is important.  It means the buyers who bought the support level with force are likely to “protect” it in the future.

Now take a look at the right circles…

BHI approached the same price zone of $36-$35 during the early days of the Gulf oil spill, the same area where volume spiked in 2009.  Notice the heavy volume coming back into BHI as it trades in the support zone.  The $36-$35 area is bought with force again.

And now BHI is trading near $50, up nearly 38% from the $36 support zone…

Do you think using volume in your charts might be rewarding?  I think so.

The bottom line is this…

By watching price action and volume, you can get essential clues on buying and selling activity.  Keeping an eye on crowd behavior is an essential part of short term trading… and finding good yogurt.

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Category: Technical Analysis

About the Author ()

Justin Bennett is the editor of Commodity ETF Alert, an investment advisory focused on profiting from the ebb and flow of important commodities via ETFs. The commodity veteran and options specialist is also a regular contributor to the Dynamic Wealth Report. Every week, Justin shares his thoughts with our readers on a variety of commodity-related topics. Justin is also a frequent contributor to Commodity Trading Research’s free daily e-letter. And he’s the editor of another highly successful and popular investment advisory, the Options Profit Pipeline.

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