Volume is the indicator which technical analysts constantly look at
to determine whether or not a move in the markets, a single stock or sector has
conviction. It may also be the easiest of all indicators to understand. Add the
number of shares/contracts traded in a given period, and you have the answer. It
requires no weightings or exotic mathematical formulas. It simply indicates
enthusiasm or lack thereof for a financial instrument and it has nothing to do
with the price of the instrument. Mastering the volume indicators can be
the ‘keys to the city' that traders look for because volume precedes
price.
To confirm a market turnaround or trend reversal, the
technical analyst must determine whether or not the measurements of price and
volume momentum agree with each other. If they do not, it is a sure indicator of
weakness in the trend, and thus a trend reversal may be well on the horizon. If
we look at volume from the standpoint of momentum we see a recognizable level of
buying and selling activity. Because volume is paramount I use five different
volume indicators in my charts, as follows;
- Up/Down Volume Indicator
- Volume Moving Average – (VOLMA)
- Volume Rate of Change – (VROC)
- Volume Oscillator – (VO)
- On Balance Volume Oscillator – (OBV)
Up/Down Volume Indicator
This indicator merely shows the total number of contracts traded, plotted
in green or red indicating whether the up or down volume was greater on that
particular bar.
The VOLMA normally plots/overlays the Volume Indicator, showing the
average volume over the last number of bars/periods. The default is typically 20
periods; however, you can adjust the input values depending upon the time frame
in use.
Volume Rate of Change
This indicator shows whether or not a volume trend
is developing in either an up or down direction. This indicator also provides
insight into the strength or weakness of a Price trend. THE VOLMA plots the most
recent bars volume and compares it to the average volume of the previous 14 bars
on a 5-minute chart (35 bars on a 2 minute chart). The results are plotted as a
value fluctuating above or below the zero line. A positive
value suggests enough market support to continue to drive prices actively in
the direction of the trend (whether it be up or down). While a negative
reading below the zero line suggests that there is lack of support to continue
the existing trend and prices may begin to become stagnant or reverse.
Volume Oscillator
The VO
uses the difference between two moving
averages of volume to determine if the
trend is increasing or decreasing. The fast volume moving average
is usually over a
period of 14 bars/periods. The slow volume moving average is usually 28
bars/periods. On a regular basis, analysts argue over whether or not the lengths
of these time periods are appropriate. Some say that 14 and 28 are too
conservative while others argue these numbers are not conservative
enough. Many short-term traders use 5-10 (fast MA) and 20 (slow MA) as
input values.
The histogram, like an oscillator, fluctuates above and below a zero
line. Volume can provide insight into the strength or weakness of a price trend.
This indicator plots positive values above the zero line and negative values
below the line. A positive value suggests there is enough market support to
continue driving price activity in the direction of the current trend (up or
down). A negative value suggests there is a lack of support and that prices may
begin to become stagnant or reverse.
A value above zero indicates that the shorter term volume moving
average has risen above the longer term volume moving average.
This indicates that the shorter term trend is
higher than the longer term trend. A
rising Volume Oscillator usually suggests a strengthening of the Trend while a
falling Volume Oscillator usually suggests a weakening of the trend. But that is
not always true. Rising prices with increased short-term volume is
bullish as is falling prices with decreased volume. Falling prices with
increased volume or rising prices with decreased volume indicate market
weakness.
The Volume Oscillator confirms price movement. When volume is
low but gains and losses are big, the professionals are most likely getting
overly excited about a possible turn in market direction. That's because
many have been taught that without strong volume a market move is not
valid. Here we look at how to interpret volume and the principles behind
doing so.
Significance. If a market is
rallying, the volume oscillator should rise. When the issue becomes overbought,
the oscillator will reverse its direction. If the market is declining or moving
in a horizontal direction, the volume should contract. Always keep in mind that
we are measuring changes in volume, and volume expands during a sell-off. It is
important to note that an increasing price together with declining volume is
always, without exception, bearish. When the market is at the top, one would
therefore see an oversold volume chart. Another important fact is that
rising volume together with declining prices is also
bearish.
On Balance
Volume
The OBV plots as a running total of volume. It adds to the running total, the
volume of each bar with a higher close than the previous bar and subtracts from
the running total the volume of each bar with a lower close than the previous
bar. It shows if volume is flowing into or out of a security. When the security
closes higher than the previous close, all of the period's volume is considered
up-volume. When the security closes lower than the previous close, all of the
period's volume is considered down-volume.
The basic assumption, regarding OBV analysis, is that OBV changes
precede price changes. The theory is that smart money can be seen flowing
into the security by a rising OBV. When the public then moves into the security,
both the security and the OBV will surge ahead.
If the security's price movement precedes OBV movement, a
"non-confirmation" has occurred. Non-confirmations can occur at bull market tops
(when the security rises without, or before, the OBV) or at bear market bottoms
(when the security falls without, or before, the OBV).
The OBV is in a rising trend when each new peak is higher than the
previous peak and each new trough is higher than the previous trough. Likewise,
the OBV is in a falling trend when each successive peak is lower than the
previous peak and each successive trough is lower than the previous trough. When
the OBV is moving sideways and is not making successive highs and lows, it is in
a doubtful trend.
The relative value or trend direction is more important than the
numeric value. For example higher prices with light volume will cause the
OBV to rise slowly indicating a lack of conviction. A rising
OBV suggests a strengthening of the trend (up or down). A falling OBV suggests a
weakening of the trend (up or down)
Once a trend is established, it remains in force until it is broken.
There are two ways in which the OBV trend can be broken. The first occurs when
the trend changes from a rising trend to a falling trend, or from a falling
trend to a rising trend.
The second way the OBV trend can be broken is if the trend changes to a
doubtful trend and remains doubtful for more than three days. Thus, if the
security changes from a rising trend to a doubtful trend and remains doubtful
for only two days before changing back to a rising trend, the OBV is considered
to have always been in a rising trend.
When the OBV changes to a rising or falling trend, a "breakout" has
occurred. Since OBV breakouts normally precede price breakouts, investors
should buy long on OBV upside breakouts. Likewise, investors should sell short
when the OBV makes a downside breakout. Positions should be held until the trend
changes (as explained in the preceding paragraph). This method of analyzing On
Balance Volume is designed for trading short-term cycles. Investors must act
quickly and decisively if they wish to profit from short-term OBV
analysis.
John Gleason is the moderator at Call The
Futures.com. His experience in emini futures tradinggoes back more years than he
cares to remember. However as his partner Dan points out he must be doing
something right to have survived this long. He calls the set ups for the Dow
& SP500 futures each day from 9:30am-12noon EST. A copy of the above article
with tables and charts is available on his dow futures blog.
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