When working with the SP500, we are provided with two pieces of information for the underlying shares- price and volume. The manipulation of these two pieces of information will be the bulk of my analysis. Volume is the measure of shares that changed hands during the specified period. Volume is also equated with liquidity. If a stock is deemed liquid, there are many buyers and sellers, and it should not be difficult to trade your shares. An illiquid stock has few buyers and sellers, so it will be more difficult to trade your shares. Since our focus is SP500 members, liquidity is not an issue we should run into with any frequency.
Examining a raw volume chart reveals that volume can have an erratic pattern. Due to this, we will work mainly with MAs of volume. I believe one should use an EMA of at least 50 periods to glean any helpful information. The EMA can reveal investors' feelings about a stock at a specific price and the trend's strength. When we see the price increasing with volume, there is support for the trend. When we see the price rising with volume flat or pointed down, we see signs of the trend not being supported. The same would be valid for a declining stock. Price in a downtrend with rising volume, supported. Price in a downtrend with falling volume, not supported. Volume can also give us indications of where bottoms are occurring. If we see that the price is flat after a downtrend, but volume is increasing, we can say that a base is being built. In other words, investors feel it is a good deal on the stock and are accumulating at that discounted price. We can also gleam that when the price is flat after a rally with volume increasing, early investors are happy with their profits and new investors feel that this higher price is a fair deal for the stock.
The Elder’s Force Index (EFI) is the other volume tool I will use. EFI is calculated by taking an EMA of the change between the current and previous periods close multiplied by the volume. The resulting EMA will oscillate between positive and negative. The EFI serves as another way to visualize the strength of trends and investors’ sentiment.