Stocks & Commodities V.

30:9 (36-44): Volume And Divergence by Gail Mercer

The Trader’s Bread And Butter

Volume And Divergence

Here’s how you can use a divergence between price and Know your buyers and sellers MAGHEN BROWN

volume for trading forex futures or exchange traded funds. After years of frustration I simply took volume off my charts
altogether, realizing I might not ever be able to read those little
by Gail Mercer sticks as others could. In lieu of volume, I opted to simply
focus on price with my analysis premise defined around price

T
he first time I looked at volume on my charts, I thought making higher highs and lows, or lower lows and highs, or
there had to be something significant in those bars, but in congestion (erratic highs and lows).
I just could not put my finger on what it was. So to find As I continued to analyze the markets that way, I revamped
out, I read books, went to seminars, attended online webinars, my understanding of volume to price with a simplified ap-
and studied all the cutting-edge techniques: the low-volume proach. This new method took my volume analysis to the
bars, the high-volume bars, the ultra high-volume bars, the following two questions: was the close greater than the open
signs of weakness, and the signs of strength. Yet on the live (buyers), or was it less than the open (sellers)? That was all
edge of the market, the concepts eluded me. I needed to know regarding volume.
Instead of trading, I found myself frozen with fear of pull- Nevertheless, I still had this feeling that volume was impor-
ing the trigger because I did not know if there were hidden tant, so I continued to look at it on occasion. Finally, I partnered
buyers or sellers behind the bar. with the principals of FulcrumTraders.com who specialize in
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Stocks & Commodities V. 30:9 (36-44): Volume And Divergence by Gail Mercer
TRADING FOREX

cumulative delta volume analysis

(CDVA). CDVA displays what
buyers and sellers are doing at a
particular moment in a candlestick
formation. It allows you to actu-
ally see the volume displayed just
like a candlestick price chart. For
the first time, this new approach
made me feel as though I might be
able to understand volume.
Although cumulative delta
allows a higher level of under-
standing of the auction process,
the technique I was attracted to
was the momentum play. I gravi-
tated toward momentum because
I understood divergence, and the
momentum play was based on
divergence. It was also the most
visual of their applications, and
this made it easier for me to grasp.
Finally, I was beginning to see
what volume analysis was all about
rather than trying to grasp vague
volume concepts.

Multicharts
Understand
divergence Figure 1: Standard Volume Bars versus Volume on Highs and Lows. Here you see the difference between
For traders who need a better standard volume bars and volume bars that coincide with a high or low. The blue volume bars indicate that the price bar
understanding of volume diver- made a high, whereas the red volume bars indicate that the price bar made a low.
gence, I will start by explaining
that the standard volume indica-
tor is nondirectional, with the The challenge was in how
volume bar beginning at zero. For
instance, when price makes higher to evaluate which volume bars
highs, the volume bars should also mattered for determining
be making higher highs. Similarly, divergence.
when price is making lower lows,
the volume bars should also be
increasing. In addition, in an uptrend, when price is making focus on my volume bars.
lows, the volume should be decreasing. In a downtrend, when Instead of concentrating on every volume bar as it related to
price is making highs, the volume should be decreasing. price, I looked solely at the volume bars that coincided with
There are many types of divergences. Divergence in its a high or a low. I designed my own volume bars and colored
simplest form is found when price makes a new high, and them in relation to whether the price bars had made either a
the volume bar corresponding to that price bar does not make high, a low, or a high and a low on the same bar (also known
a new high. Divergence is also found when price makes a as an outside bar).
new low and the volume bar corresponding to that new low Figure 1 illustrates the difference between standard volume
is not higher than previous volume bars. It is of the upmost bars and volume bars that coincide with a high or a low.
importance to remember that the volume bar indicator is When the price bar made a high, I colored the volume bar
nondirectional. blue. When the price bar made a low, I colored the volume
Now that I had a better understanding of volume divergence bar red. If the price bar made a high and a low on the same
and how it worked, I started focusing on analyzing volume bar, then it was necessary to look at the close of the price bar
bars. The challenge was in how to evaluate which volume to determine the significance of the volume bar. If the price
bars mattered for determining divergence. Instead of looking bar made neither a high nor a low, then it did not convey any
at every volume bar, I realized that the important volume bars useful information, and consequently, it did not need to be
were those where price makes a high or a low. This led me to displayed. These volume bars are left blank.
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Stocks & Commodities V. 30:9 (36-44): Volume And Divergence by Gail Mercer

Figure 2: Euro THREE-Minute Chart on Col-

ored Volume Bars. Anytime price makes a high (blue
volume bar), you compare the present blue volume bar
to the previous volume bar where a high occurred.There
is divergence when the new high is on lower volume.
Similarly, anytime price makes a low (red volume bar),
you compare the present red volume bar to the previous
volume bar where a low occurred. If the bar is gray, you
look at the close of the price bar. A close that is greater
than the open is considered an up bar. A close that is
less than the open is considered a down bar.

Bar-by-bar analysis
The three-minute chart of the euro/US
dollar (EUR/USD) in Figure 2 displays
the colored volume bars. Since I know
that I only need to compare the volume
bars coinciding with a price high and
the volume bars coinciding with a
price low, the analysis is substantially
simplified. Anytime price makes a
high (blue volume bar), I compare the
present blue volume bar to the previous
volume bar where a high occurred.
There is divergence when the new
high is on lower volume. Similarly,
anytime price makes a low (red volume
bar), I compare the present red volume
bar to the previous volume bar where a
low occurred. If the bar is gray, I need to
look at the close of the price bar. A close
that is greater than the open is considered
an up bar. A close that is less than the
open is considered a down bar.
Beginning at point A as price began
the pullback, the blue volume bars
increased. Then as the new lower
high completed, the blue volume bars
decreased, indicating divergence. At
point B, price made a high and then
came back to retest the high.
First, you need to identify the highest
volume bar associated with a high. In
this case, it is a gray bar in which the
close was greater than the open. Next,
you compare this volume bar to the
volume bar on the highest high, which
in this case is lower. This indicates
divergence, and in such a case, price
is expected to go lower in accordance
with the divergence.
At point C, price made a low. At
point D, when the low is first tested,

FIGURE 3: Downtrend Comparative Volume

on Lows. The selling climax occurred at point A. Each
subsequent low was on lower volume (divergence),
indicating a weakening of the downtrend (point B).

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Stocks & Commodities V. 30:9 (36-44): Volume And Divergence by Gail Mercer

FIGURE 4: DOWNTREND ENTRY. Look for the price bars making

a high. Then looking back to where price started to pull back to
that high, identify the tallest volume bar that occurred as price
was making highs. This becomes the volume bar to which the
bar on the ultimate high of the small pullback will be compared.
Then determine whether there is divergence at the highs.

the volume bar is higher. However, although

price and volume behaved according to
expectation for the first retest of the low,
the next two bars came back to retest the
low, each on lower volume. This signals a
potential market bottom.

Volume behavior
In addition to the bar-by-bar
analysis, it is also possible
to analyze volume behav-
ior as the trend develops.
In this case, since price
is making lower lows and
lower highs, the trend is
down. As shown in Figure
3, the selling climax occurred at point A.
Each subsequent low was on lower volume
(divergence) indicating a weakening of the
downtrend (point B).
Incorporating this analysis into a trading
plan is simple. For instance, if price is in a
downtrend, as illustrated in Figure 4, look
for price bars that are making a high. Then,
looking back to where price started to pull
back to that high, identify the tallest volume
bar that occurred as price was making highs.
This becomes the volume bar to which the
bar on the ultimate high of the small pullback
will be compared. Then determine whether
there is divergence at the highs.
Similarly, for an entry in an uptrend,
look at the volume on each low and repeat
the procedure as described in the opposite
direction to identify the measuring down
bar. Then compare the volume bar on the
last low to that measuring bar to determine
whether there is diverging volume on the
lows. This is illustrated in Figure 5.
Will this technique work on a variety of
markets and time frames? The answer is
simple: as long as there are price and volume
bars, the technique will work. This can be
demonstrated by looking at a few different
markets and time frames.

FIGURE 5: UPTREND ENTRY. For an entry in an uptrend, look at

the volume on each low and repeat the procedure in the opposite
direction to identify the measuring down bar. Then compare the
volume bar on the last low to that measuring bar to determine
whether there is diverging volume on the lows.

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 Stocks & Commodities V. 30:9 (36-44): Volume And Divergence by Gail Mercer
FXA Weekly ARCX TRADING FOREX

Applying it to ETFs
First, let’s look at a couple of currency exchange traded funds
(ETFs) examples. Figure 6 is the weekly chart of CurrencyShares
Australian $ (FXA). Each vertical line represents where price
has made either a high or low. Although the price seems to be
in congestion, the entry point can easily be identified for either
longs or shorts, simply on the basis of the volume patterns at the
highs and lows.
In addition to the CurrencyShares ETFs, there are also
ProShare ETFs, which aim to double the daily performance of
a specific currency. The first two vertical lines on the weekly
chart of ProShares Ultra Euro 2x Long (ULE) in Figure 7
identify the volume divergence and potential entry into the
uptrend. The last vertical line shows the divergence at the top
of the market, signaling a profit-taking opportunity.
FIGURE 6: CURRENCYSHARES AUSTRALIAN DOLLAR ETF (FXA). Each vertical
line represents where price has made either a high or low. Although price seems to After taking profits in the ULE, we will shift our attention to
be in congestion, the entry point can easily be identified for either longs or shorts an ETF that performs opposite to ULE — that is, the ProShares
simply on the basis of the volume patterns at the highs and lows. UltraShort Euro 2x Short (EUO). The weekly chart of EUO
in Figure 8 identifies the area of accumulation (yellow box),
followed by five vertical lines that correspond to the volume
ULE - Weekly ARCX divergence on the lows and possible entry points.

Applying it to equities
The next market example is taken from a weekly chart of
Apple, Inc. (AAPL), that shows an uptrend (Figure 9). The
possible entry point is ascertained by looking at the lows

AAPL - Weekly NASDAQ

FIGURE 7: PROSHARES ULTRA EURO 2X LONG ETF (ULE). The first two vertical
lines identify the volume divergence and potential entry into the uptrend. The last
vertical line shows the divergence at the top of the market, signaling a profit-taking
opportunity.

EUO - Weekly ARCX

FIGURE 9: WEEKLY CHART OF APPLE, INC. (AAPL). The first blue verti-
cal dotted line identifies where price made a low on diverging volume, thus
FIGURE 8: PROSHARES ULTRA EURO 2X SHORT ETF (EUO). Here you see the providing the entry point. Price goes on to make new highs and eventually
area of accumulation (yellow box) followed by five vertical lines that correspond to gives a short diverging volume on the high, indicating that profits should be
the volume divergence on the lows and possible entry points. taken. Then as price begins to pull back, new lows are being created. On
the last blue vertical dotted line, price has made a new low on diverging long
volume, providing another potential entry to the upside.

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Stocks & Commodities V. 30:9 (36-44): Volume And Divergence by Gail Mercer
TRADING FOREX

PCYC - Weekly NASDAQ WU12 - Daily CBOT

FIGURE 11: DAILY CHART OF SEPTEMBER 2012 WHEAT CONTRACTS

and determining whether there is long volume divergence at that

point. The first blue vertical dotted line identifies where price made
FIGURE 10: DAILY CHART OF PHARAMACYCLICS (PCYC). The entry in
the uptrend was generated by a single volume divergence on the lows.
a low on diverging volume (the red volume bars are increasingly
smaller as price proceeds lower), thus providing the
SQ12 - 5 min CBOT entry point. Price goes on to make new highs and
eventually gives a short diverging volume on the high
(second blue vertical dotted line), indicating that profits
should be taken.
Then as price begins to pull back, new lows are
being created. Upon measuring the selling volume
coinciding with the lows, it is easy to see that on the
last blue vertical dotted line price has made a new low
on diverging long volume, providing another potential
entry to the upside.
On the daily chart of Pharmacyclics (PCYC), as illus-
trated in Figure 10, the entry in the uptrend was generated
by a single volume divergence on the lows.

What about commodities?

Volume divergence analysis works just as well in com-
modities as it does with ETFs and equities. The daily
chart of September 2012 wheat contracts in Figure 11,
the five-minute chart of August 2012 soybeans contracts
in Figure 12, and the three-minute chart of August 2012
FIGURE 12: FIVE-minute chart of August 2012 soybeans contracts

“Dad, Eddie and I are expanding our lemonade business. Our IPO is coming up soon and we
thought you’d like to have first crack at it. Can we put you down for a couple of million?”

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Stocks & Commodities V. 30:9 (36-44): Volume And Divergence by Gail Mercer
@GCQ12 - 3 min COMEX @ESU12 - 3 min CME

FIGURE 13: THREE-minute chart of August 2012 gold contracts

Volume divergence analysis FIGURE 14: THREE-minute chart of September emini S&P 500 contracts.
works just as well in Each of the vertical lines represents an entry into the downtrend based on diverging
commodities as it does with volume resulting in a three-point move every time.

ETFs and equities.

Is it the holy grail of trading?
gold contracts in Figure 13 illustrate the same concept. The Once again, this demonstrates that this divergence technique
only difference is a change in the symbol and time frames. is simple yet powerful, providing an edge for any experienced
Finally, will it work for those who like to scalp the mini trader. Is it the holy grail? Absolutely not, but it will often
S&P 500? Yes. The three-minute chart of the September emini explain why support did not hold, or why a trend reversed just
S&P 500 contracts in Figure 14 illustrates how effective this as it started to accelerate. The technique is substantially more
technique is for scalping during the market opening on July powerful when executed and integrated with price reversal
6, 2012. Each of the vertical lines represents an entry into the patterns, support/resistance levels, multiple time frames,
downtrend based on diverging volume, resulting in a three- gap analysis principles, and within liquid markets having
point move every time. sufficient volatility.

Gail Mercer is a trader, director, and instructor for trader-

shelpdesk.com, and is known as an indicator expert. Mercer
hosts a free live trading room where she teaches forex and
index traders how to approach the markets. She currently
trades futures, forex, indexes, and stocks.

Suggested reading
Mercer, Gail [2011]. “Empowering Traders With The Russell
2000,” Technical Analysis of Stocks & Commodities,
Volume 29: March.
_____ [2010]. “Looking At Other Markets,” Technical Analysis
of Stocks & Commodities, Volume 28: May.
‡MultiCharts

“My campaign promise: The US government will no

longer prop up puppet governments overseas.”

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