Stocks and commodities tend to move up and down based on the forces of supply and demand, and more specifically based on the imbalances between these two forces. Very relevant to this trading action is the concept of trading volume, a quantity which measures the number of shares or contracts that were traded on each day in the markets. The important thing to point out here is that high trading volume, in general, is seen as being supportive to the underlying trend, so an up trend with heavy volume will be seen as a stronger up move in the market, than an up trend with low, below average trading volume. So heavy volume is very often associated with support to the market trend, and in most cases this is the case. But when this trading volume keeps on rising and rising with each trading day, then despite the classic view that more volume is good, at some point the continuously rising volume will bring a point of imbalance. This point of imbalance in the market is when there are no more buyers, or no more sellers available to keep the two sides well balanced. As a result the market loses momentum, and is unable to penetrate through the next level of resistance or support, and a reversal takes place.
So in effect, rising volume every now and then, followed by days of back to normal volume, is a good thing, this does not create imminent reversals. But when the market has been moving either up or down, and trading volume is rising slowly and steadily with each trading day, then a reversal becomes imminent, as a point of imbalance is set to be triggered in the days ahead. This phenomenon is known in the financial markets as lack or presence of Ease of Movement, and there are indicators for measuring this ease of movement, or in other words how easy or how hard it is for the market to continue to move in the direction that it is already moving.
Traders want to see rising volume with every move, but not a pattern of smoothly rising volume. A pattern of uniformly, steadily rising trading volume, formed over several days, hints that some reversal is bound to happen as the market will run out of either buyers or sellers, requiring a reversal lasting usually at least few days. One technical indicator that traders use to detect such patterns is the Ease of Movement or EMV indicator. When the EMV indicator rises too much, it warns that it is becoming harder and harder for the market to continue to rise. Equally, when the EMV indicator drops too much, it warns that it is becoming harder and harder for the market to continue to decline, hence warning traders that these are times where the probability for a reversal is much higher.
The EMV indicator and its theory goes against intuition, because many long term investors have a rather simplistic view on trading volume, simply being as ‘black or white’, either high or low volume. And they consider one thing as good and the other as bad, so when they migrate to short term investing and trading they still have these beliefs. But trading volume can form smooth patterns over several days and force the market to make a reversal, so trading volume in short term trading and investing is not as simple as being either high or low. It all comes from the forces of supply and demand, and the continuous need for having enough buyers and sellers to make trading possible for everyone.
The SP500 index (above), with its daily trading volume seen in black and red bars, and its EMV indicator chart (below). Notice the EMV indicator is derived out of the daily trading volume but the relationship is not easy to spot, as the EMV rises when there is a pattern of steadily rising volume, or almost steadily over few days, but when the EMV falls, there is not necessarily a falling pattern on the daily volume chart. The market reversals are possible to detect using the volume bars alone, but the EMV indicator provides a smoother reading which makes things much clearer.
Using the Ease of Movement indicator together with other indicators can help traders pay more attention to certain signals over other questionable signals, and even avoid false signals and subsequent losing trades. If the EMV indicator is warning of a potential reversal in the coming days, even though it cannot pinpoint the exact day, the trader has enough advance warning to look out for signals on the charts and on other indicators, signals that will confirm and maybe even pinpoint the expected reversal day.
Volume based indicators are generally hard to use and require too much attention to detail. The EMV indicator is an exception, since it is a simple volume based oscillator which is quite easy to use and combine together with other indicators. Trading volume by itself has almost no meaning, it is only when this trading volume is compared to and studied against price action, that meaningful conclusions can be inferred. Markets become unstable every once in a while, as market price has extended beyond supply and demand sustainable balance levels, and therefore becomes bound to return to balance again by reversing, at least for a while. This is why market price is not actually always right like many claim it is, and the EMV indicator proves this and helps traders detect these reversals easier.
