How to Judge Trend Quality by Analyzing Volume and Swing Points
In L.A. Little's book, Trend Trading Set-Ups: Entering and Exiting Trends for Maximum Profit, Little says that the strength of a trend can be judged by how a stock reacts as it moves over (or under) a previous swing point.
The basic idea is this:
In an uptrend, if a stock closes over the previous swing point high on increased volume, then the trend is "confirmed" and has a higher probability of continuing higher than if the stock closed over the previous swing point high on lower volume.
Here is the reasoning behind it:
The idea behind the confirmation is that, for whatever reason, buyers were willing to purchase a greater number of shares at higher prices than had heretofore been paid to obtain a share of this company's future.
If a stock closes over the previous swing point high on lower volume, then the trend is "suspect" and has a lower probability of continuing higher.
Here is an example:
See how you are comparing two candles and the volume associated with each?
In this example, the volume of the candle breaking out over the swing point high candle is higher - so this trend has a higher probability of continuing (confirmed). If the volume of that breakout candle had been lower, then you would view this trend as having a lower probability of continuing higher (suspect).
This technique for measuring trend strength is applicable to all time frames. And it works on downtrends as well - just reversed. For downtrends, you are looking at breakdowns through swing point lows.
How might this help you as a swing trader?
1. Let's say you bought this pullback (between the green bars on the chart above). Then the stock blasted through that previous swing point high (on increased volume). You may consider holding on to this stock for a longer period of time since it has an increased probability of continuing higher.
2. Let's say you were thinking about trading this stock on that second pullback (the one after the green bars on the chart above). You may choose to trade this stock over others because you saw that the breakout over the previous swing point high was on increased volume - and thus the probability of the trend continuing was high.
The idea that volume is important as it moves over swing points is something that you may already know - intuitively. This book provides the backtesting to back up that idea.
There are some other price action techniques in this book including how to identify "anchor bars and zones". Also, there is a whole chapter on trading pullbacks that is worth the read.
It's rare for me to find a technical analysis book that offers anything new.
This book is the exception!