Volumetric analysis & trading

The definition of volume given in the book "Technical analysis of financial markets" by John J. Murphy is as follows:

"The volume is the number of entities dealt during the time period taken into consideration" ... "The volume level measures the intensity or urgency that is behind a price movement."

But from a practical point of view, how should the volume be interpreted?

The fundamental rule is that the volume must expand in the direction of the trend. This means that:

• if we are in an uptrend we expect volumes to be high during upward movements and low during downward corrections;
• if we are experiencing a bearish trend, we expect volumes to be high during downward movements and low during bullish corrections.

 

Analysing the volume on the Dax Index:

Looking at the chart we can see that as prices reached the higher levels (see black box), there was no confirmation that volumes continued to increase – this is the first sign that the uptrend could have reached the end.

Immediately afterwards we see that, at particularly negative days (vertical red lines), we have an increase in volumes, a signal that the trend has reversed, moving definitely from bullish to bearish.

The Chaikin Oscillator to calculate the pressure of sellers and buyers

The Chaikin oscillator measures the pressure of buyers and sellers, determined on the basis of the position of the closure with respect to the maximum and minimum:

• We have positive pressure (accumulation) if the closure is in 50% of the positive range;
• We have negative pressure (distribution) if the closure is in 50% of the negative range

Here is the indicator applied to the Dax Index:

As we can see in the figure the upward trend is supported by volumes, so much so that the prices, in point 2, reach a new maximum compared to point 1, confirmed by the oscillator.

In point 3 instead the new maximum is not confirmed by the oscillator which, as easily visible, remains below the previous maximum.

In point 4 we confirm that something has gone wrong, so much so that the indicator has values much lower than the maximum of previous prices, and indeed the upward trend leaves room for the downtrend.

The volume indicator – On Balance Volume

In technical analysis, among the indicators of volume, the best known is the OBV (On Balance Volume), by Joseph Granville, which offers a first approximation on the pressure of buyers and sellers.

The formula for calculating the on-balance volume is very simple, in fact it is enough to cumulate the volumes of the various days. In particular:

• if the closure is positive then the volume is added
• if the closure is unchanged, do not add anything
• if the closing is negative then the volume is subtracted

The following chart shows the DAX index and the on-balance volume:

The divergences that occur when the on-balance volume line moves in a different direction than that of prices is very important, signaling a possible inversion of tendency.

The OBV (blue line) often has the ability to anticipate price inversions.