Number 7

Please note that we have used historical data. These examples are for educational purposes only.

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Volume Indicators

Many analysts believe that volume precedes price, and a divergence between volume and price will soon be reflected in the price movement itself.

In addition to watching volume itself, there are some very useful indicators that incorporate volume data into the calculations. These include On Balance Volume, Money Flow Indicator, Volume Accumulation Oscillator, Demand Index and Price Volume Trend. These indicators are complementary to most of the others that are available (such as MACD, oscillators such as RSI and ROC, Directional Movement, etc.) because they take volume into account.

It is strongly recommended that you become familiar with one or two of the Volume indicators to gain a more inclusive, complementary perspective on price movements.

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NEW YORK (Reuters) - Wall Street staged an explosive comeback on Friday as robust results from high-tech companies and bullish comments from a top Wall Street analyst emboldened investors to snatch up battered stocks.

The technology-packed Nasdaq Composite Index (.IXIC) soared 241.74 points, or 7.86 percent, to close unofficially at 3,316.42, after Thursday's mauling of 94 points took it to the lowest level since early November 1999. The Nasdaq snagged its second-largest percentage gain ever.

The Dow Jones industrial average (.DJI), the closely watched gauge of 30 blue-chip companies, roared up 157.60 points, or 1.57 percent, at 10,192.18. On Thursday, the Dow suffered its fifth-largest point slide ever and settled at its lowest level since March 14, 2000.

The broader Standard & Poor's 500 Index (.SPX) climbed 44.32 points, or 3.33 percent, to 1,374.10, after hitting its lowest close to date this year in the prior session.

Looking at the Dow, the diamond formation shown in the last issue of the ChartFilter newsletter has been broken on the downside. This move represents a breakout from a significant triangle pattern and should be watched carefully. If support holds, it may be a sign of a continuing sideways market. If not... the bears will have all sorts of fun rampaging around.

There's no doubt that the volatility of the past few months will be staying with us for a few more months at least. What can we learn from volume indicators in these turbulent times? Read on...

Let's take a look at a daily price chart showing the current DJIA and the recent wild gyrations of October 12-13th.

Volume normally leads prices, except for the occasional volume spike, as we saw on October 12th. In this case a spike is a negative indication, since it was accompanied a sharp drop in prices.

However, a sudden price change accompanied by volume spikes could be forming a pattern known as a reversal day. Reversal days take place either at a top or a bottom. A bottom reversal day occurs when prices set a new low in a downtrend, followed by a higher close. The wider the range for the day and the heavier the volume, the more significant the signal for a possible near term trend reversal. This may be what occurred on October 12th for the Dow. (The close was only slightly higher than the low of the day). We'll have to wait and see...

In the chart below, a volume spike can also be seen on the chart for the NASDAQ index. It's also interesting to note the uptrend in the volume for the Nasdaq over the last couple of months, diverging from the trend of the index itself. I wouldn't stake any money on it, given other indications and the volatility we're experiencing, but this could be taken as a possible bullish scenario for high-tech stocks. Before taking any action, however, you'd be wise to look at this sector very carefully using some of the other tools we've discussed.

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TIPS & TECHNIQUES - Using Volume Indicators

Price and volume give you two separate tools for measuring the same thing - pressure. John Murphy writes in his book, Technical Analysis of Financial Markets, "The level of volume measures the intensity or urgency behind the price move. Heavier volume reflects a higher degree of intensity or pressure."

Volume normally increases in the direction of the price move; that is, in an uptrending market volume is normally increasing as the price moves higher, and vice versa. When prices are being pushed higher, it's evident that there is more buying than selling pressure. It makes sense, then, that the greater volume should take place in the same direction as the prevailing trend.

Analysts have experimented with many volume indicators to help quantify buying or selling pressure. The simplest and best known is On Balance Volume (OBV) developed by Joseph Granville in the '60s. It has shortcomings, however; because it assigns an entire day's volume a plus or minus value, even if the market closes up or down by only a tiny amount. Consequently, somewhat better indicators have since been developed that are more sensitive to volume versus price.

The Money Flow Indicator, developed by Laszlo Birinyi, Jr., is a real-time version of OBV that tracks the level of volume on each price change to show how much money is flowing into or out of a stock. The Volume Accumulation Oscillator (VAO) allocates a proportional amount of volume to the mean price of the period, depending on the position of the close relative to the mean price.

For detailed information see the reports on OBV, MFI, VAO and PVT.

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Gateway Inc. (GTW)

Gateway made a big jump on Friday the 13th. The prospects for Gateway are apparently good, what can we learn about this stock using the volume indicators? Let's take a look using On Balance Volume and the Money Flow Indicator.

Here's a one year price chart for Gateway (NYSE: GTW), along with volume, OBV and MFI. As usual, trend lines are drawn to clarify historical action for this stock.

In using OBV watch for the direction, or trend, of the line, not the numbers (if there are any - they've been omitted on this chart). The actual OBV values will differ depending on how far back you are charting. OBV will often give you a better picture of the trend than the price action, and definitely a much better view of the volume trend than the volume chart itself. In the example above we can see that it mirrored the price and volume action, acting as confirmation.

The MFI line tends to be more sensitive to both price and volume action than OBV, and can be used to confirm trend line penetrations on the price chart. As you can see above, MFI caught the market bottom in late May much earlier than OBV did. MFI also offers oversold and overbought indications; when it goes above 80 you have overbought (bearish) scenario and when it goes below 20 you have an oversold (bullish) scenario. A good example is the signal (green arrow) in early October when MFI went below 20 for the first time in a year, followed by the recent surge in price. Also notice how useful this has been in the past in catching the peaks in this market (red down arrows on the price chart).

If you like to trade fast paced markets, you can see that MFI in particular will help you in taking advantage of short term moves.

Whatever your trading style, however, it is a good idea to become familiar with the use of volume and volume indicators to assist you. If you rely entirely on indicators using price alone you will be missing out on a whole set of valuable information offered by volume data.

Putting ChartFilter into Context

ChartFilter is meant to complement your overall trading knowledge and decision-making. This newsletter focuses on applying technical analysis (TA) methods to various markets; but this is not to say that you shouldn't be considering important fundamental criteria, such as EPS or revenue, as well. Think of ChartFilter as your TA assistant; not as your overall trading strategist.