Monday, June 20, 2011

Volume Indicator Experiment

Let's turn up the Spinal Tap Amps here...
In the equities market, high volume can occur from capitulation or irrational exuberance. In fact, conventional wisdom has traders looking for equities with volatility spikes as a trigger. The problem is that high volume can occur anywhere along the cyclical range of an equity. It can occur at the bottom of the range, the middle run, or the top of the range.

What started this First Experiment
This thought process started with the idea that price, volume and $volume [price * volume] give different information to a trader; However, can the same technical indicators for price be used for volume or $volume?

There are several forward looking technical indicators for price volatility, such as the S&P volatility index ($VIX) &  CBOE Nasdaq Volatility Index ($VXN). There are several backward looking technical indicators for price.

First Experiment
What if the key to volume analysis is not the high volume signal, but the appearance of a low volume tick. Low volume indicates indecision or indifference. This volume data should be looked at in relative terms.

A backwards indicator for price is the relative strength indicator (RSI). I took the RSI indicator and used it on an equities' historical volume data. The volume data is very erratic but it did show a trend. Volume can vary tremendously from one day to the next or it can remain constant for months. What was interesting was to  increase/decrease the time period averages to de-emphasize/expose a volatility spike. For example, using the standard 14 period average seemed too long for the volume data trend.

Second Experiment
I'm in the middle of taking the S&P ($SPY) historical volume data RSI and comparing it to an individual equities' volume RSI. It is requiring  longer time frames to even out cyclical trends. For example, the S&P could be at the top of its periodic range and the individual equity could be at its bottom.  Maybe I could work out a correlated volatility of the broader market as a whole. Sort of like a Beta of volume volatility. Send me a note if you think of something.

With a quick glance towards the equities market, it appears that low volume is a forewarning of a spike in volume. Barring any external events, does the length of the relative calm indicate indecision or indifference?

What about a forward looking indicator? Can you think of a predictive volume indicator, usually based on another criteria, that can be modified?

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