BEWARE:  RISING PRICE AND FALLING VOLUME

After a brief detour into "buy on stop" orders last week, I want to continue with the principles of volume analysis. This week, I want to draw your attention to the danger raised by a stock when its price is rising, but at the same time its trading volume is trending lower.

But before we get to this, as a brief refresher, here are the major points we've already covered regarding volume in recent issues:

• Traders must always look at price patterns in conjunction with their associated volume pattern, never alone. A stock may appear to be in a head and shoulders pattern, but the volume pattern must confirm that analysis.

• Careful analysis of the volume of selling that occurred above current resistance will help you estimate how long a stock will stall at that level.

• Well-above-normal volume is essential when separating a true from a false breakout above resistance.

• Well-above-normal volume on the break of a key support level is likely to keep the swing trader from making the mistake of shorting into a deceptive "spring" formation.

• Climactic volume can occur after a sustained downtrend. The retest of the support level of the selling climax can provide a good trading opportunity if it is accompanied by low volume (as compared to the selling climax).

Why is it so vital to be aware of volume when the price of the security you're examining is rising?

There are few events so satisfying to the swing trader as seeing a stock one has purchased go in the "right direction" -- the direction you predicted. It is, after all, changes in price that make traders money.

Let's say you are long a stock and it is trending steadily higher. You come home, bring up the chart on your screen and note that the stock is up another 2% on the trading session. Not much need to analyze it further, you may think. It's going in my direction and it's obviously in an uptrend.

This seduction of rising prices, however, can distract the swing trader from doing what he/she should be doing -- a complete, thorough technical analysis of the trading position with particular attention to its volume pattern. If a stock is truly in a healthy uptrend, then volume should rise as prices rise. If this is the case, then the volume indicates that buyers are chasing the stock. This increases the probability that the uptrend will continue.

Volume, however, can be very erratic. A light volume day on the market may easily translate to a light volume day in your stock. It is unusual for volume to rise every single day during an uptrend. The solution to the dilemma is to draw a trendline on the volume chart in the same way you draw a trendline on the price chart. The two trendlines should be moving in the same direction. If they are not, then you probably have a situation called "negative volume divergence." Price is rising, but volume is declining. This divergence indicates that even though demand still outweighs supply, buyers are not willing to pay up to own the stock. Such a pattern can signal that the uptrend is running out of steam and should put the swing trader on alert for a trend reversal.

Recent trading in storage giant EMC Corp. (EMC) is instructive of the dangers of paying attention only to rising prices. As shown by the chart below, EMC bottomed in late July. It then began an Intermediate uptrend (defined as a trend that lasts between three and 13 trading weeks). At the beginning of the uptrend, volume was very strong, with many days being above the daily average.

In mid-September, EMC almost touched $14.00, formed a doji candle (this indicates indecision on the part of buyers), retreated and found strong support at $13.00. From here, as is shown in the circled area, the stock rallied again, retesting $14.00. During this circled period, the stock finished in positive territory in five of six days. I've drawn a trendline under this area of the chart.

Now notice the volume pattern. During this rally, volume was light. It was consistently under the average daily volume level. Secondly, and perhaps more important, it trended down while price trended up. Note the down trendline I've drawn on the volume chart during this six-day period.

Shortly after this period of negative volume divergence, EMC experienced a sharp sell-off and broke its Intermediate uptrend line. Even before the trendline break, however, a trader holding EMC long (one with a firm grasp of important volume principles, of course) should have been on the alert for a potential reversal.

A rising price brings smiles to the faces of traders who are long. However, when prices rise during a period of declining volume, this pattern can eventually cause tears of frustration. As such, alert swing traders should always be on the lookout for negative volume divergence.

Income Security of the Month If you're looking for high yields, monthly payments and unprecedented safety from your investments, then you need to learn more about our "Income Security of the Month" for November 2008. This stable preferred stock has a long track record of paying some of the most solid dividends in Wall Street history. In fact, the preferred issue pays a monthly dividend totaling 10.3% annually and has outperformed the S&P 500 by more than +44 percentage points over the last year!

Top 10 Stocks for 2008! Since we began publishing this report back in 2003, the picks we've featured have consistently beaten the broader market -- delivering average gains of +21.3% per year and outperforming the S&P by a nearly 2-to-1 margin. Act now to reserve your copy of our newest report -- Top Ten Stocks for 2008.