ACCUMULATION DISTRIBUTION VOLUME 2 By Daryl Guppy

Last week we left you with a volume display.

We asked you to use the volume chart to identify the time points at which you believe volume shows these changes in trend. The full chart display matching price with volume shows how difficult this task really is. The boxes match the time period of the trend change. There is no clear relationship between volume and trend turning points. In some cases there is a decline in volume as the trend makes a major change such as change B. Elsewhere major volume spikes occur in the middle of trends and do not have any impact on the trend.

We assume there is a volume relationship,

but we rarely test it rigorously. This idea has become an accepted convention and forms the foundation of several technical and fundamental analysis techniques. It is so commonly accepted that we no longer seriously put it to the test.

This assumed relationship did not develop and gain acceptance unless it was, at one

time, significant. As with some aspects of market analysis, this volume work dates back to the first half of the last century. It was significant then because the total volume of trading in the market and the total number of people involved in the market was exceptionally small. Jesse Livermore was the last significant trader to make effective use of these relationships, even as they were changing in his time with the growth of market participation in the late 1920s. The explosion of market participation in the 1990s confirmed the change in these volume relationships but most traders still cling to the ideas developed more than 60 years ago.

SUBJECT SUMMARY DISTRIBUTION AND ACCUMULATION

At the top and bottom of market moves price activity slows and briefly shows a consolidation or broadening pattern. At market tops this is a distribution pattern. Canny traders sell stock at high prices to less skilled market participants. They distribute their holdings.

At market bottoms these same canny traders accumulate stock from sellers who have given up in disgust. These patterns are not sudden. They develop slowly, keeping prices within a temporary trading band on steady volume. When these patterns coincide with GMMA crossover points in two time frames we get additional confirmation of a major trend change.

Yes, we did select a chart where these relationships were not strong because we

wanted to illustrate several points. First were those cumulative changes in volume behaviour do not necessarily identify points of trend change. The analysis of traded volume, without reference to other factors, does not provide a solution for understanding trend behavior, trend change or trend continuation.

The second point was that volume analysis, as usually applied, cannot be applied to all stocks. There may be a coincidental relationship, but these coincidences are too infrequent to allow this assumption about volume and trend changes to be applied with any level of confidence. Despite this we will continue to hear commentators talk about these relationships as if they are a firm established fact.

The third point, not shown on this chart, is that any volume and trend relationship must

be broadly applicable to all stocks without regard to liquidity, velocity of trading, or quantity of turnover.

Belief in this relationship is difficult to unseat so we include two more charts which

illustrate the lack of volume and trend relationship. The first is ANZ. The vertical liens show key trend change points. They are not associated with any significant volume relationships.

The second chart is a lower priced and lower volume chart. Perhaps with less liquidity

this trend and volume relationship may be clearer. The answer is still in the negative. After the trend break AGO develops a steady long term trend. Volume is lower than in the previous downtrend.

The analysis tools commonly used to analyse volume all rest on the assumption that the

trading activity on a daily basis, or on an average daily basis, is a measure of trending activity in price. These indicators measure the changes in relationship between those who are active in the market and who have a bullish or bearish perspective. To better understand the role that volume plays in trend analysis we need to broaden our understanding of market behaviour and of the range of participants in the market.

This brings together two separate concepts. The first is accumulation and distribution. The second is the way in which traded volume is related to available volume. ACCUMULATION

Our understanding of volume comes from three sources: fundamental, intuitive and technical. Fundamental analysis uses volume as a measure of liquidity. Intuitively we believe volume is related to changes in price activity. Technically we apply several indicators to track changes in volume and its significance. On a broad basis we talk of accumulation and distribution phases in the market. It is interesting that although these phrases are part of our analysis vocabulary, they are not related to volume. They are most frequently described with reference to chart pattern behaviour.

These concepts are important because they provide a link between volume and trend

analysis. The accumulation phase develops where existing shareholders believe the stock has no future. In disgust they sell the stock to smarter investors who have decided the down trend has, or is about to end. Classic theory suggests that these are investors who have made superior analysis based on fundamental analysis. These are the investors buying quality stock at lower than fair value. They are accumulating.

On a technical basis, this accumulation activity may be identified with a number of chart patterns. These include consolidation bands, double bottoms, trend line breakouts, saucer patterns and the development of support areas. These patterns suggest that the selling pressure has been halted as buyers come into the market. This accumulation phase is not marked by rapid changes in price or a new trend. However, the accumulation precedes the development of a new trend as eventually others in the market are also alerted to the potential for a new up trend in the stock.

The reverse applies to a distribution phase. This occurs when investors believe the stock is overvalued. It also occurs when some investors are aware of developing bad news. The assumption is that this is based on superior fundamental analysis. Prior to the trend change, smart investors begin to sell stock. This selling creates several chart patterns.

These chart patterns include head and shoulder reversals, rounding tops, resistance levels, consolidation bands etc. These patterns are technical confirmation of the distribution activity. In classic theory accumulation precedes a trend change, and distribution precedes a trend change. This is illustrated on the diagram and is an important starting point for trend volume analysis.

This theory fails to address some significant issues. It leaves no room for continuation pattern behaviour in mid trend. It does not provide us with a way to understand mid trend weakness and to distinguish this from end of trend behavior. Next week we show how this concept is applied when we include the ideas associated with available volume. AVAILABLE VOLUME

The market is a mechanism driven by supply and demand. This is economics 101.

Todays price is decided by the balance of supply and demand but only amongst those who are active in the market today. The order line today reflects the balance of supply and demand buys and sellers on this day only and only for a small proportion of those who own shares. It does not reflect the total supply of shares for the company. On any given day, the total number of shares on issue by the company are not available for trading. Only those shares held by those willing to sell are available for buying.

The market for shares is made up of four groups. The first is those people who own shares in the company. The second is those people who own shares and who have decided to sell them. The third is the group of people who do not own shares (or enough shares) and wish to buy shares. The fourth group is those who do not own shares and who do not wish to buy shares at this time. We can ignore the last group because this latent demand cannot be measured effectively. What is particularly important is the interaction between those who want to buy shares and those who have shares and who choose to sell or not sell.

This interaction takes place within a defined context. That context is the total number of shares available for trading by the public. This is the starting point for trend volume analysis. The relationship was originally explored by Gann. The idea also forms a foundation of the Standard and Poors methodology in determining the construction of an index. More recent work, with a Gann analysis perspective has been done by Woods and Arp. This is free float analysis.

How do we determine the free float analysis figures? Publications such as Huntleys Shareholder are an important starting point. They list the substantial shareholders along with the total number of shares on issue. The entry for HHL in the 2006 edition shows there are 24 million ordinary shares on issue. The top shareholder holds 53.3% of the shares. Combined, the top 4 shareholders hold 72% of the shares on issue. This is a tight share registry.

By comparison, HHV has an open share registry with 214 million shares on issue. The largest single shareholding holds 6.6% of shares on issue. This is a larger pool in which traders can play.

There are several problems with this information.

First Huntleys Shareholder covers the top 500 stocks. Coverage of the remaining two thousand plus stocks listed on the exchange is much more limited. Locating this information is much more difficult.

The second problem is that this information is accurate as of November 2005. Getting up to date information as changes develop is a more time consuming task.

The third assumption is more significant. The Gann analysis and Standard and Poors assumption is that those shares held by the largest shareholders, or which are locked up for other reasons such as Government ownership, or in escrow, are non-tradable. These shares do not form part of the free float.

We believe that the free float analysis is crippled on several grounds. The diagram

shows the way the publicly available shares, or circulating shares, may be divided up. This includes shares owned by the company directors or their nominees. These may be a significant proportion of the available shares. A significant number of shares may be held by fund managers and institutions. These may also be restricted in their availability for trading. Finally there are the public owned shares. The HHV example shows a company with many public circulating shares. The changes in the mix of company, fund and public shares have a

significant impact on the trading activity in a stock. This is not considered by free float analysis based on share registry analysis.

The first is the assumption that large shareholders lock up their shares and do not trade them so they are not included in the free float calculations. The assumption is that these shares are not available for trading by the general public, so the number of shares included in the free float is reduced. Standard and Poors use a variety of methods to determine an exact figure for the free float. This is used to decide which stocks are included, or excluded from the Stand and Poor's Indexes. In Australia, Telstra is not included in the ASX S&P 200 because the Government owns 51% and so the free float is reduced.

The second is that free float analysis as used by Standard and Poor's essentially stops once it is applied to the selection of stocks suitable for inclusion in an index. This is very suitable for S&P business, but it fails to recognise the importance of free float style analysis.

The third is that the market is ineffectively analysed using a free float figure calculated or based on company share register information and assumptions.

The fourth is related to our discomfort with additional Gann style analysis as applied by Woods and Arp. We feel that forcing free float analysis into this Gann framework is not the most efficient application of the free float volume methodology.

Given these assumptions we make an important change to the application of free float

analysis. There is a difference between the official number of shares that are available for trading by the public, and the actual number of shares that are traded. Rather than calculating a figure, we want to take this figure from the activity of the market.

The free float is an important starting point for analysis. We want to take this a step

further to develop this into Trend Volume analysis. Instead of telling the market what it is supposed to be doing by using a precalculated free float figure, we use market activity to provide a Trend Volume figure. This is used to identify accumulation, distribution and continuation volume behaviour. Next week we show how this is applied using the new Trend Volume analysis tools in the GTE Charting software upgrade.