How to Use Volume to Determine Trend

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How many times has the market made what you thought was a change in trend (i.e., bull to
bear). You took a short position then found the market turned and went up substantially.
By the time you or your stops caught the bad position, you probably lost.
For those of you who are Elliott wave counters (figure 1), the market you were in finished
up a bull wave 5; you thought it was forming waves 1, 2 and the starting of wave 3 of a bear
cycle you went short. Instead, you found it was a corrective A-B-C pattern then waves 1 and
2 of a new bull cycle where you should have gone long. This can also occur in a bear trend,
fooling you into thinking it has shifted into a bull cycle as well.
A similar unfortunate mistake can happen when the market is shifting from a bull to a bear
trend (or vise versa), and you think it is an A-B-C correction. In fact, it is waves 1,2 and the
start of wave 3 of a new trend cycle. By the time you figure this out, it’s too late to take a long
position; it would be too risky by now.
I keep referring to the market. One of Charles Dow’s basic tenets was to always buy
with the trend of the market, i.e., don’t buy a commodity/stock that is in a trend against or
opposite the rest of the market.
Some of the traditional methods of determining the market’s trend is to use head
and shoulders, slow moving averages (SMA), breaking trend lines, oscillators and watching
for gaps, etc.. These help to confirm ones thoughts. Even if you use envelopes, lters or
more than one SMA at a time, they can still whipsaw. Usually, at best, they will give the
conrmation quite late.
Let’s face facts here. Knowing which trend you are in and which Elliott wave count you
are on (as soon as possible) is the name of the game. Other indicators such as RSI, Lane’s
Stockastics, William’s %R, Gann fixed angle lines Fibonacci fan and arc lines, etc used in
combination are fantastic at telling you when to expect the exact day of a short term turnaround.
These commonly used indicators are also found in the program I have written entitled “END
OF THE RAINBOW.” If ind that knowing when to expect these short term turnarounds help you
determine the beginning and end of each Elliott wave – thus you know when to buy and sell
provided you are in the correct trend . END OF THE RAINBOW also has a cycle finder and
price target lines predicting the minimum and maximum of wave 3 and 5. These indicators, in
themselves, can not tell you for sure which trend you are in while at the beginning of a trend
cycle. This is when you will want to start your position.
How can one know which trend the market is in early in the game? Charles H. Dow gave us
a few hints. One of his famous basic tenets was to assume the market is still in the existing trend
until proven otherwise (this is helpful provided the market has not shifted trends). In my opinion,
the most important basic tenet Dow gave us is ‘the volumes must confirm the trend.
This right and left translation notes the time position of each wave’s peak in relation to the
adjacent troughs. (Notice I said peaks and troughs). In a bear cycle, the end of impulse waves
forms the troughs and the corrective waves produce the peaks. If the commodity/stock is in a
bull cycle, the peak is supposed to be to the right of center. In a bear cycle, however, it leans

to the left. The screen output, (as shown in gures 3 and 5),
is a horizontal neutral line with vertical-bars—(blue) above
or below the neutral line and a slow moving average of the
bar graph (light blue). When the bar graph and SMA are
above the neutral line, it is bullish. On the other hand, when
the bar graph and its SMA are below the neutral line, it is
considered bearish. At the bottom of the graph is another
bar graph (magenta) and its SMA (pink) indicating each
days volume. This slow moving average can be removed,
if desired, to view the bars more clearly. Figures 2 and 4
are the price lines of that stock. Finally, below the graph
the screen prints the average volume during the entire time
of the file and it prints that day’s volume (each divided
by 100 ) .
Note that in example A, (gures 2 and 3), the stock
(Digital Equipment) did indeed go into a change of trend
from a bull to a bear cycle. If you felt that wave 1 was a
bullish A-B-C and wave 2 and the start of wave 3 was a
wave 1 and 2 of a bull cycle – you would have been rudely
awakened. With VOLUTREND you would not have taken a
long position as the indicator went bearish in time to warn
you to go short. Note example B in figures 4 and 5, (Apple
Computer). This stock did form a complex corrective A-B-C
pattern – then wave 1 and 2 of a new bull cycle.
You could have successfully taken a long position at
the start of wave 3.
It is always wise to wait to take a position until the
start of wave 3 rather than the start of wave 1. Wave 2 will
many time completely retrace wave 1. By that time you
will feel more confident about the trend in which you are
actually involved. Getting out of the position at the end of
wave 3 or 5 is a matter of opinion and how strongly you
entire market is acting.
Reference: Technical Analysis Of The Futures Markets:
A Comprehensive Guide to Trading Methods and Applications.
John J. Murphy (1986), New York Institute of Finance
NewYork, N.Y. 10270
James H. Burnett has been writing technical analysis
graphic programs for over 3 years and instructs a class
entitled “Stock Market Mechanics” at his local community
college. James is also the president of the investment
club, NNIC.
He can be reached for more information concerning
“END OF THE RAINBOW”. “END OF THE RAINBOW” also
has an automatic file downloader. It loads your data files
daily from your T.V. cable, even while you’re on vacation.
 

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