Ask Colin

How important is volume in breakouts?

The detailed question was:

I re-read your book The Aggressive Investor recently, also Stan Weinstein's Secrets for Profiting in Bull and Bear Markets. They are both excellent books, in my opinion.

I note at page 161 of your book you said "...my experience with the Australian stock market is that many good breakouts occur without an increase in volume, so I no longer worry about the volume."

Stan Weinstein at page 103 of his above book states "...never trust a breakout that isn't accompanied by a significant increase in volume"

I am puzzled about these differing views on volume. Admittedly, Stan's book was published in 1988 and the US market may have changed in this regard.

I would appreciate your comments on the above differing views about the importance of volume in breakouts.

I don't think there is cause to be puzzled and I am sorry if I have been the cause of your difficulty here. There are several issues I would raise in this matter.

 

Firstly, volume is a very minor part of charting. I would put it at less than 10% of the data on which a chartist would make a decision. I will readily admit that some chartists would give it greater importance, but that is my opinion born of my experience.

 

Secondly, I think there is a possibility that the US and Australian stock markets are different. This would be likely especially with regard to the NYSE, where all the stocks are large and trade in deep liquid markets. The same is not true of the ASX, where this might be true of less than 100 of the 1600-odd traded securities. This might explain why my experience and Stan's is different. I do not think this is something that has changed over time, but I have not studied it and I may well be wrong.

 

Thirdly, I have no argument with Stan's investment plan with respect to volume. I think it is very sound and I would trust his judgement with respect to his market. There is no reason why you should not extend it to your plan in the local market, so long as you recognise that it is based on another market rather than your own. As such my feeling is that it would be overly conservative and lead you to miss quite a lot of good opportunities. Then again, I am an aggressive investor and you may be more conservative.

What should you do about this? I suggest that you define the Australian stocks that you trade or invest in. Then study at least 10 years of history for them looking for the proportion of winners and losers that was confirmed by a volume spike on the breakout. You need to record both the winners which were confirmed by volume and the ones that were not. You also need to record the failures that also had or did not have confirming volume on their breakout. Once you have the complete picture in this way, you will be able to form your own opinion on what works for the stocks and time frame in which you trade or invest.

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