Understanding Volume Analysis Techniques in Trading
Introduction to Volume Analysis Techniques
Volume analysis is a key technique used to assess the strength of market trends and identify potential reversals. It involves the examination of the number of shares or contracts traded within a specific period. The basic premise is that volume precedes price. Hence, any major changes in trade volumes can indicate a significant change in market sentiment. This article delves into various volume analysis techniques that traders and investors can use to make informed decisions.
On-Balance Volume (OBV)
On-Balance Volume (OBV) is a momentum indicator that uses volume flow to predict changes in stock price. Joseph Granville introduced the OBV metric in his 1963 book, “Granville’s New Key to Stock Market Profits.” OBV shows crowd sentiment that can eventually translate into price movement.
How to Calculate OBV
If the closing price of the current period is higher than the previous one, the volume of the current period is added to the previous OBV. Conversely, if the closing price is lower, the volume of the current period is subtracted from the previous OBV.
Volume Price Trend (VPT)
Volume Price Trend (VPT) is another technique that combines price and volume to form a cumulative running total that can indicate the strength of a given trend and potential reversals.
How to Calculate VPT
The VPT is calculated by multiplying the change in price (compared to the previous day’s close) by volume, then adding this to the previous VPT value.
Volume-Weighted Average Price (VWAP)
The Volume-Weighted Average Price (VWAP) is a trading benchmark used by traders that gives the average price a security has traded at throughout the day, based on both volume and price. It is important because it provides traders with insight into both the trend and value of a security.
How to Calculate VWAP
The VWAP is calculated by adding up the dollars traded for every transaction (price multiplied by the number of shares traded) and then dividing by the total shares traded.
Market Volume Index (MVI)
The Market Volume Index is a volume analysis technique that compares the volume of a specific market to a base period. It can help traders identify periods of unusual volume activity.
How to Calculate MVI
The MVI is calculated by dividing the volume of the current period by the volume of a base period, then multiplying by 100.
Conclusion
Volume analysis techniques provide valuable insights into market trends and potential reversals. By understanding the implications of various volume indicators like OBV, VPT, VWAP, and MVI, traders and investors can make more informed decisions and potentially improve their trading performance. However, as with any trading strategy, volume analysis should be used in conjunction with other tools and techniques to confirm signals and avoid false positives.