Average buyers of stocks are a drop in the bucket in terms of how they impact daily stock transactions (volume) compared to institutional buyers. The institutional buyers only buy in large blocks. When institutional buyers get into the market, they cause significant increase in demand. Like any case of supply and demand, when demand increases and supply stays the same, price will increase. When a stock becomes desirable, it is more likely that supply may decrease (as current stockholders will be less willing to sell) which will cause even more price pressure. The more one institutional buyer impacts price and volume, the more other institutional buyers will get interested in the stock and be motivated to buy the stock as well.
It stands to reason then that the greater volume should take
place in the same direction as the prevailing trend
Now lets look at how volume can cause stock prices to fall. If institutional buyers start dumping a stock, the supply will radically increase. Typically, demand will decrease at the same time as other institutions will either 1) concur that the company’s value has declined or 2) be motivated by the others selling the stock. As we know, when sellers outnumber buyers the stock price will fall.
In a downtrend, the volume should be heavier during down moves and lighter on bounces. As long as that pattern continues, the selling pressure is greater than buying pressure and the downtrend should continue. It’s only when that pattern begins to change that the chartist starts looking for signs of a bottom.
Price is a Function of Herd Mentality
Based on this volume precedes price analysis, it is probably obvious that there is a herd mentality when it comes to the market. When one institution is buying a large block of stock in a company, other institutions will spot the buying and be motivated to jump in as well. This increases the pressure on the stock price. You and I are small investors so it is important to join the herd and let the supply and demand caused by the institutions carry our investments higher. Standing on our own and ignoring the direction of the market and of of a stock is typically a bad idea. It may sound like a good idea to buy a stock when it develops a new low but what will stop the stock from continuing to fall. It is typically the market pressures of institutional buyers that will carry your investments to higher prices.