“Analysis of volume, or the number of shares of stock being traded, is a subject worth careful study. It can certainly help you recognize if a stock is under accumulation or distribution. Once you acquire this skill, you won’t have to rely as much on the personal opinions of analysts and experts. Big volume at major points is indispensable.” – William J. O’Neil, MarketSmith Founder
Let us break it down with a simple analogy to understand this further. Assume that you have a ticket for today’s Indian Premier League opening match between Mumbai Indians and Chennai Super Kings. However, you have to cancel your plans at the last minute. You are now trying to find a buyer for your ticket. Assume that it is transferable, and it had cost you Rs 1,000 initially.
Given that it is a popular event, say you have three colleagues who are willing to buy it from you. Here is a conversation that could take place.
You: Guys, I bought this ticket for 1,000 bucks, and I know each of you would want to go to the game. Decide which one of you wants this.
Colleague 1: Listen, I can give you 100 bucks extra, why don’t you give it to me for a small profit.
Colleague 2: 100 bucks? M.S. Dhoni will be donning Chennai colours after two years and I don’t think I could get another chance to watch such a special event. I can give you 200 bucks. Let’s call it a deal.
Colleague 3: You know what! I promised my kid to take him to the match as it’s his birthday. I was busy with work, but managed to get hold of just one ticket. I can’t disappoint him. Here is 1,500. Take it or leave it.
Colleague 2: Boy, I would say 1,500 is too much to ask, even for Dhoni. I think I can throw a party and watch the match at my home for that money!
Colleague 3 buys it from you at Rs 1,500, at a neat 50% mark-up. The demand (three buyers) simply outweighs the supply (one ticket) and this resulted in the ticket price shooting up. This is exactly how a stock’s price goes up!
The beauty of the CAN SLIM investing system is that it trains you to look for stocks with high demand, whose price is likely to appreciate further. Two aspects of the CAN SLIM strategy that capture the demand for a stock are ‘S’ and ‘I’.
‘S’ stands for Supply & Demand
The key here is to watch for stocks breaking out of chart patterns and making new highs on strong volume. From William O’Neil’s historical research, he observed that big gains came after stocks broke out of their bases with their volume being above average – at least 40-50% higher. The higher the volume, the more welcome it is.
‘I’ stands for Institutional Sponsorship
How is this for a fact? As of March 2018, the average AUM size of India’s equity mutual fund scheme was about Rs 1,531 crore. It is not unusual for mutual funds to hold anywhere between 30-60 stocks in their portfolio. Assuming that a fund owns about 50 stocks in its portfolio, it could end up investing over Rs 30 crore into a single stock. That is a huge sum, which could significantly move up the price of a mid- or a small-cap stock!
It is a known fact that retail participation in the Indian stock market is limited, and it is the big, institutional money that drives the prices up for a stock. What is a simple way to gauge institutional interest in a stock?
Simply check if there is a growing fund ownership in the stock you are interested. We typically suggest watching out for stocks with a growing ownership for at least three consecutive quarters.
Actionable Tools
Volume % Change: Stocks, like people, are different. One stock may have an average trading of 10,000 shares a day, another 100,000 shares a day, and still another, a million shares a day. If a 10,000-share per day stock suddenly transacts 70,000 today, the stock has witnessed a 600% increase in volume that indicates heavy selling or buying.
Very often, specialists on the floor of the stock exchange and most professional portfolio managers, as well as many savvy public investors, follow the ‘volume % change,’ often missed by retail investors.
Accumulation/Distribution Rating or Buyer Demand Rating: Another technique to watch for institutional buying is to watch for accumulation in the base, i.e., the stock going up on high volume, but going lower on low volume. The A/D rating and its trend over the past few weeks can be used to determine this. You can also watch every week’s price action on a chart to view this on a graph. The blue volume tower lines crossing the average volume line should be greater than the magenta volume tower lines.
Here is an example of a fundamentally-strong stock that displayed massive accumulation and huge volume % change as it broke out to new high ground in late February 2018.
In addition to the above two factors, make sure you also use the institutional sponsorship data for a stock available under MarketSmith India’s Details section.
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