Volume Based Technical Analysis
Critical Volume Signals
One significant aspect of volume analysis is an understanding of the importance of volume-based generated signals. In an analysis of volume surges, critical volume is considered to be a volume surge that most likely will lead to a strong trend reversal in which the reversal movement is not short lived, but prolonged in time.
The common strategy used to define which volume surge or volume based signal is critical is to compare the current volume and signal to the previous surges and signals. This strategy can be applied not only to the volume-based technical indicators, but also to other technical studies as well. The other strategy of defining critical signals (that could be used in junction with the first one) is consulting longer timeframes to define the parent trend stages.
You must remember that the main definition of technical analysis is the comparing of the current market/stock trend characteristics to the historical market/stock trend with the objective of predicting possible trend development. Before making a trading decision, a professional technical analyst or trader always consults history and a longer-term timeframe.
Understand Critical Volume Signals by consulting the history
Comparing the present volume-based signals to the historical signals is one of the simplest way to define the strength of the current signal - that is, to determine if the current signal is critical.
In the case of Stochastics, when you trade 20 and 80 levels, it is difficult to evaluate the present signal in relation to historical signals because all signals are generated at the same level. The only thing that you can do is to check how long Stochastics moved below 20 or above 80 and determine how strongly oversold or overbought the stock, index or market is. When it comes to volume-based signals in technical analysis, with most indicators, you can compare how strong a signal is (how big the volume surge is) and how a large bearish or bullish volume accumulation is associated with this signal.
It is easier when you see a big volume surge over a prolonged period of time. This volume based signal is strong (big volume surge) and can be considered to be a critical signal (volume), which could lead to a strong trend reversal. However, in some cases, you may see a series of smaller signals that are not strong enough to be considered to be critical signals. As a rule, in this case you see a weaker reversal reaction to each of these signals. Yet, at some point, the cumulative volume accumulation of the small signals could reach a critical point at which those small signals can be compared to one strong signal. Furthermore, a reaction to a row of small signals could be equally strong.
The small volume signal (surge) can be considered to be critical if together with the cumulative volume of the previous small signals it has volume accumulation similar to the volume accumulation witnessed in the previous strong reversal.
On the S&P 500 chart below you can see an example of signals generated by the SBV oscillator (Selling Buying Volume Oscillator). The first signal is strong. You can see how deeply the SBV Oscillator dropped below zero and you can see how large the bearish volume accumulation was (big red SBV area). As a result, the S&P 500 rallied strongly upward – a strong reaction to a strong signal. Next, you can see a row of small signals. The bearish volume accumulation (red SBV areas) is small. Each of these signals pushed the S&P 500 index higher, but the reversal was not very strong. At some point, the bearish volume accumulation of the small signals became approximately equal to the bearish volume accumulation seen in the case of the first strong signal. The last volume signal in the row of small signals can be considered to be a critical signal because it brought the cumulative bearish volume accumulation to the critical level. As a result, after that small signal, the S&P 500 made another strong rally upward that was similar to the upward move after the first strong signal.
Chart1: S&P 500 (SPX) chart with examples of critical signals.
NEXT: Real-Time Charts
Copyright 2004 - 2013 Highlight Investments Group. All rights reserved. This material may not be published, broadcast, rewritten, or redistributed.
Our pages are constantly scanned. If we see that any of our content is published on other website, our first action will be to report this site to Google and Yahoo as a spam website.