The indicators we have previously mentioned relate to two dimensions of market analysis, namely time and price. Most technicians recognise a third dimension, which is volume. In addition, commodity traders analyse open interest numbers for supply and demand considerations.

The volume of trading activity for each time period is normally shown at the bottom of a standard bar chart. Each period’s volume is recorded by a vertical bar directly below that period’s price bar.

The chart below shows the daily volume levels for Apple shares.

AAPL Volume

The higher the histogram bar, the higher the volume for that period. A vertical scale can be used along the bottom of the chart to help plot the data.

Basic Rules of Volume

Volume is viewed as a measure of market strength or weakness. If volume is increasing while prices are movivng either up or down, it is likely that prices will ocntinue their current price trend. On the other hand, a decline in volume is considered to signal that steam is running out in the direction of the current trend and consolidation or a reverasl could be forthcoming. Historically, volume has related to market prices as follows:

Price Volume Implication
Rising Heavy or rising Bullish
Rising Light or falling Potentially bearish
Falling Heavy or rising Bearish
Falling Light or falling Potentially bullish

Blow offs and selling climaxes

Dramatic market action that is common at market tops and bottoms is known as blow-offs and selling climaxes.

Blow-offs occur at tops. They usually occur after prices have moved higher over an extended period of time. At the end of the up move prices rally sharply accompanied by a large increase in volume. Typically, all of those that were going to buy at this level have done so. Profit taking occurs and prices reverse, often suddenly, to the downside.

Selling climaxes are simply the opposite of blow-offs. They occur at market bottoms after prices have been declining for an extended period of time. One final wave of selling drives prices sharply lower n significant increased volume. Bargain hunters then jump in buying, reversing the trend and sending prices higher.

Unfortunately, these indicators are extremely difficult to identify until after the reversal has occurred, since, in normal circumstances, you’d expect a move higher (or lower) in heavy volume to confirm the continuation of the uptrend (or downtrend), not an imminent sharp reversal!


On-Balance Volume (OBV)

On-balance volume is a technique of volume analysis that has been popularised by Joseph E. Granville, author of ‘A New Strategy of Daily Stock Market Timing Profit’ (Prentice Hall, Eaglewood Cliffs, 1976).

On-balance volume is calculated in two steps. First, each day’s total volume is deemed as being positive or negative depending whether prices closed higher or lower than the previous day. If prices close higher, the total volume is considered “positive”; if prices close lower, the total volume is considered “negative”. Then each day’s positive or negative value is summed in a running cumulative total, so:

If today’s close is greater than yesterday’s close then:

Today’s OBV = Yesterday’s OBV + Today’s Volume

If today’s close is less than yesterday’s close then:

Today’s OBV = Yesterday’s OBV – Today’s Volume

If today’s close is equal to yesterday’s close then:

Today’s OBV = Yesterday’s OBV

The actual value of on-balance volume is not important. Its direction relative to market price provides clues to buying and selling pressure. As with many cumulative indicators, on-balance volume is interpreted analysis:

Price OBV Implication
Rising Rising Bullish Confirmation
Rising Falling Bearish Divergence
Falling Falling Bearish Confirmation
Falling Rising Bullish Divergence

The basic assumption of OBV analysis is that OBV changes preced 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).

On balance Volume

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.

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.

  1. The first occurs when the trend changes from a rising trend to a falling trend, or from a falling trend to a rising trend.
  2. 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 or 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 preced 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).

Weighted On-Balance Volume

Weighted OBV is similar to normal OBV, but takes the actual amount of the price move into consideration so that the greater the price move (close-to-close) the more the WOBV will be affected.

WOBVt = WOBVt-1 + Vt (Ct – Ct-1)

Where:

  • WOBVt = Today’s weighted OBV
  • WOBVt-1 = Yesterday’s weighted OBV
  • V1 = Today’s volume
  • Ct = Today’s closing price (or current price)
  • Ct-1 = Yesterday’s closing price

 

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