(By Greg Guenthner) Sometimes, a stock's price doesn't tell the entire story. That is why it is so important to confirm a price breakout using additional evidence. The more evidence you have that a breakout is genuine, the more likely it is that any given trade will be successful.
You can confirm a stock's breakout using a variety of techniques. Some are simple. Others are quite complicated. The indicator I'm going to explain today is actually very easy to understand. You don't have to be a mathematician to use it, either. Best of all, it is incredibly accurate. If you learn to use it correctly, it will help you wipe virtually all of the bad setups off your trading radar.
The indicator I'm talking about is trading volume. Volume is simply the number of shares exchanging hands over any given time period. Take a look at the following chart:
On most free charting websites, you can find volume bars located below the price (red box), with a separate legend indicating the values located on the left side of the chart opposite the stock's price (blue box).
Here's how you use it:
First, look for significant changes in volume near breakout levels. Let's say you've spotted a potential breakout stock that you want to trade. As the stock price moves into your breakout zone, check the daily volume bar. As the stock price moves higher, volume should also increase. This confirms that more buyers are willing to step in and pay higher and higher prices for the stock.
Next, compare the current volume to the volume bars from the past couple of weeks. You'll want to see a significant increase in volume during the breakout. It's not just about a high number of shares trading. It's about seeing a higher than average number of shares trading. A stock with 2 million shares exchanging hands doesn't mean anything if it has averaged several million shares trading every day for weeks or months.
This is where charts come in handy, because you can quickly and accurately see volume spikes on a volume histogram…
Let's turn to the very same chart I showed you above for a real-life example of a stock that broke out yesterday:
If you were watching the $14.75 area for a breakout (blue line), you could easily use volume to confirm the move higher was legitimate. Looking at volume along the bottom of the chart, you can tell that on the average day, about 100,000 shares of LGND exchange hands.
However, yesterday saw approximately 300,000 shares exchange hands (circle). That's a substantial increase — more than enough to confirm the breakout was legit. Today is further evidence that this stock's move is accelerating to the upside. The price gapped higher, and trading volume increased again — this time to more than 750,000 shares —well before the closing bell. Had you bought on the breakout coupled with the volume confirmation, you would be sitting on massive gains in just 24 hours…
The next time you are looking to buy a stock that appears to be breaking out, double-check how many shares are trading. It takes only seconds — and it will help you separate the most powerful breakouts from the weaker moves.
for The Penny Sleuth