The issue of benchmarking when applying the volume price analysis methodology is one I have covered in other posts, but I thought it would be worth reinforcing the point using an example of a stock I have written about extensively, and that’s Caterpillar (NYSE:CAT).
In this example, I have taken the monthly timeframe as this is a classic example of two things. First, as a signal for existing investors to consider closing positions, while for those latecomers a warning to stop and think before jumping in on the fear of missing out, or FOMO.
The initial rally of 2020 was signaled by strong buying on the hammer candle which initially saw the stock price break below $100 per share only for it to recover and close above the two platforms of support denoted with the red and blue dashed lines of the accumulation and distribution indicator.
Then the rally gets underway, and once we have a break of the volume point of control the stock moves steadily higher, until the wide spread up candle takes the stock soaring through the $200 per share level. However, note the volume. At best it is average and indeed the following candle has higher volume on a narrower spread of price action.
For such an extreme move in price, we should expect to see a dramatic increase in volume, at least two to three times what we have here! This is a clear anomaly when considered against other benchmark candles with similar volume where the price action is half this or less. This tells us immediately the market makers are not participating and are in fact merely marking prices higher as evidenced by the following candle, and selling into weakness between $220 per share and $230 per share.
So in summary, comparing one candle and its associated volume with another, either where the price spread is equivalent or the volume is of comparable size, gives us an insight into whether a price move is genuine or false. In this case, it is clearly anomalous and the resulting bearish engulfing candle a couple of months later was the trigger for the reversal which has seen Caterpillar back below $200 per share.