Stocks & Commodities V. 23:6 (30-37): Spike Up The Volume by Giorgos Siligardos, Ph.D. INDICATORS
Leading Or Lagging?
Spike Spi ke Up The The Volu Volume me A long
spike appearing in the volume histogram usually catches your attention. But how do these spikes in volume really affect indicators and prices?
V
olume can be considered to be the fuel of the markets. When the daily trading volume of a security is extremely high compared to its average daily values, that means it’s attracting a large number of buyers or sellers. Oftentimes, this huge rush leads traders awry. In his article “A Tale Of Two Indicators,” Andrew Tomlinson gave an interesting example of two volume indicators that diverge, giving opposite signals. The daily volume spike along with a gapping down hammer created these signals, and Tomlinson noted that this divergence was due to the nature of the formulas of these volume indicators. Here I will discuss the concept of volume and show that volume spikes actually do not provide signals that indicate which way prices will go, but rather provide instantaneous alert signals.
THE TWO-FACED BUS THEORY One of the basic guidelines of classic technical analyan alysis is that bullish periods need high volume to continue, whereas bearish periods could continue without the need of high volume. Moreover, when the volume starts to fall in a bull market, it suggests su ggests that a bearish market is near. An analogy from physics is a “two-faced” bus, like those airport buses with two driver’s seats used to transfer passengers and person-
by Giorgos Siligardos, Ph.D.
nel, moving up and down a hill. The bus represents the tradable, the height of where the bus is on the hill represents the price of the security, and the trading volume represents the fuel of the bus. When W hen the fuel starts to diminish, the bus may stop advancing and fall back due to its weight and the laws of gravity. If the bus driver wants to go down the hill and has enough fuel, he or she may step on the gas pedal and the descending acceleration will be much stronger than the natural acceleration of the gravity. This simulates the idea that bear markets accompanied by high volume are extremely severe. The two-faced bus theory also models consolidation periods with diminishing volume. This is when the bus runs out of fuel and needs to wait until its fuel tank is filled again. Only after the fuel tank is filled can the bus decide where it wants to go. How are volume spikes represented in this model? By a sudden filling of the fuel tank. When this happens, the bus may travel a long way in the direction it wants. As soon as the fuel tank is suddenly filled, the will of the bus (if it had a will) — not unlike an 18-year-old boy with a brand-new car filled with gasoline — instantaneously becomes unpredictable (which may be the reason why many oscillator developers advise not to use oscillator signals accompanied with high volume). Let us explore e xplore this situation further using a common-sense approach. SENTIMENT FACTOR AND VOLUME NEUTRALITY In his Japanese Candlestick Charting Techniques, candlestick expert Steve Nison asks a rhetorical question: “What is the most significant price level for a trader/investor on any chart?” Though this question seems to be quite general, Nison’s answer is disarming: “The most significant price level for a trader/investor is the price level at
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Stocks & Commodities V. 23:6 (30-37): Spike Up The Volume by Giorgos Siligardos, Ph.D.
S N W O D A L L E B
Copyright (c) Technical Analysis Inc.
Stocks & Commodities V. 23:6 (30-37): Spike Up The Volume by Giorgos Siligardos, Ph.D.
which he/she entered the market. People become emotionally attached to the price at which they bought or sold.” Nison used this argument to explain the sentiFirst Energy Corp. ment factor that makes sup(Utilities) B port/resistance levels important, the implications of their breakouts, and the change A of polarity principle (that is, Chaikin A/D oscillator broken support becomes resistance and broken resistance becomes support). This argument could be extended further: Since the On-balance volume most significant price for a trader is the price at which he/she entered a Volume position, you could say that the most significant price level for a security is the level considered most FIGURE 1: WHO IS RIGHT? On the daily chart of First Energy Corp. (FE) the volume indicators diverge at bar A, giving ambiguous signals. significant by the majority of traders — that is, the and firm signals to save you from false breakouts. I will also price levels at which high trading volume takes place. It wouldn’t be prudent to extract immediate conclusions show, through another example, that volume spike analysis from a price bar with high volume without knowing at least a can be applied in almost all markets. little of the movement that follows this bar. The rationale for this is hidden in the direction neutral ity of volume (also noted VOLUME INDICATORS by Tomlinson). While a price movement can be classified by AND INCONSISTENCY definition as bullish or bearish, volume itsel f cannot be classiLet’s look at an example simified as bullish or bearish. Bulls buy the security expecting to lar to the one that Tomlinson gain profit. Bears sell the security expecting to gain profit. used in his article. In Figure 1 Who is right? you see a daily chart of The bulls, as much as the bears, may have opposite opinions FirstEnergy Corp. (FE). There about the market, but they all try to gain profits and they all are also three subcharts showagree on the price level that they buy/sell the security. Volume ing the performance of Chaikin simply represents the number of all agreements without bias. accumulation/distribution A high-volume bar just says, “I am significant because there is much hope or despair in me.” But it is the movement that (Chaikin A/D), on-balance volume (O BV), and volume itself. follows the high-volume bar that will indicate who will finall y Three vertical white lines are added for visual clarity. It is clear be right. If the price drops after the high-volume bar, it me ans that the gapping down day (bar A) had a terrible effect on both the bears are right. If the price ris es after the high-volume bar, Chaikin A/D and OBV. OBV gave a sell signal and Chaiki n A/D gave a buy signal. What happened next? Chaikin A/D started it means that the bulls have the upper hand. But a new problem now arises: How much movement is declining and indicating that it was perhaps not a good idea to needed after the appearance of the vol ume spike to pinpoint the buy in the first place. OBV, on the other hand, started advancright direction? There is no certain answer to this question, but ing, showing that it was perhaps not a good idea to sell in the considering the sentiment factor at support and resistance first place. Then another volume spike appeared (bar B), and levels, you’ll find that there will oft en be a breakout of a short- both indicators screamed “Buy”! But after that, in spite of or medium-term support/resistance after the high-volume bar prices and OBV continuing to advance, Chaikin A/D started declining, suggesting a bearish situation was near. that can be used to indicate the direction of prices. From this you could conclude that O BV was more consisVolume spikes provide leading alert signals and lagging direction signals. I will show you three examples where you tent, but what if someone had followed its first sell si gnal after will see the usefulness, or lack thereof, of volume indicators the downward breakout at bar A? The downward O BV movement at bar A broke a historical support level of OBV, which and how volume-spike analysis could provide more confident Copyright (c) Technical Analysis Inc.
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Stocks & Commodities V. 23:6 (30-37): Spike Up The Volume by Giorgos Siligardos, Ph.D.
made the sell signal even stronger from the perspective of classic technical analysis. This is an example of how relying on the behavior of volume indicators at volume spikes as direction signals creates nothing more than confusion. But if you consider their behavior as an alert, you’ll see that signals are more consistent. In this example, both indicators were correct. They were both (each in its own way) saying the same thing: “Something is going on here!” But most people interpret an instantaneous upward movement of an indicator as a buy and a downward movement as a sell.
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L1 A
L3 B
? L4
C
L2
Great Plains Energy Inc.
Chaikin A/D
OBV
Volume
FIGURE 2: DAILY CHART OF GREAT PLAINS ENERGY INC. Chaikin accumulation/distribution and on-balance volume give ambiguous signals at high volume bars A, B, and C.
SPIKES, SENTIMENT, AND RATIONAL THINKING Let’s look at this example from the perspective of sentiment. A gapping-down white candle occurred at point A with very high volume. Because of the appearance of the white candle, basic technical analysis suggests this is bullish for the short term and bearish for the long term (because of the downward gap). After the formation of the gap, it is reasonable to expect prices to test the upper level of the gap before declining to new lows. But volume spikes make things complicated and you need to see how things will proceed before you act. At this stage (based only on the information shown), a closing price slightly below the low of the white candle (bar A) could be considered a possible sell signal. But as you can see from the chart, price advanced and stopped above the upper boundary of the gap after A. Then you were confronted with another unexpected price movement. Another big white candle (bar B) appeared, accompanied by a volume spike, similar to the previous one. Here is where things become interesting. Since the gap is now filled, it is my guess that you are slightly more bullish than bearish but still not sure because of the high-volume bar B. However, you could consider two levels to give you direction signals. You could consider the low (or slightly below) of the white candle (bar B) as a support level which, when broken, will give a sell signal with a first targe t of 25.82 (the low of bar A). You could also consider the high (or slightly above) of the white candle (bar B) as a resistance level which, when broken up, will give a buy signal. These two threshold levels are illustrated as red horizontal lines in Figure 1. The upper threshold was crossed approximately 10 bars later and as can be seen, it was a solid signal (blue arrow). The small pullba cks
after that (small downward red arrows) did nothing more but make the buy signal even more confident. Now, take a look at the two spikes and their implications. The first spike implied a reversal, and the second spike implied a continuation. But you can’t reall y be sure who bought or sold at bar B. All you can do is suspect t hat those who sold at bar B were of two kinds: Those who had not sold before the firs t gap down and now have an opportunity to break even, or t hose who bought at bar A and wanted to lock in t heir profits. In any case, the buyers proved to be right.
A SECOND EXAMPLE In Figure 2 you see a daily chart of Great Plains Energy (G XP) along with Chaikin A/D, OBV, and volume. Here again I have added vertical black lines for visual clarity. You can clearly see three volume spikes at bars A, B, and C. If you consider the behavior of the O BV at these points as a signal, you would have been thrown off course. The same thing would have happened if you had also considered the behavior of the Chaikin A/D as a signal at bars B and C. At least in this example, both volume indicator signals suggest the same direction at B and C. Again, the behavior of the indicators at the spikes is not incorrect if they are considered to be alerts for a significant event (considering the general volume behavior outside those spikes). Nor are volume indicators usele ss all the time. It is the spikes that distort the regular movement of volume indicators
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Stocks & Commodities V. 23:6 (30-37): Spike Up The Volume by Giorgos Siligardos, Ph.D.
and provide ambiguous direction signals. For exAvery Dennison 200-period simple moving average ample, from bar A to bar B, OBV supported the upward price move and indicated the correct direction. But how can you get reasonable and more solid signals using the information from the spikes? Chaikin money flow In this case, at bar A you could use level L1 as a threshold for a buy signal Chaikin A/D and level L2 as a threshold for a sell signal — that is, a OBV closing price above L1 or one that is below L2 is the trigger. You don’t want to Volume set a threshold level that is too close to bar A because it could be risky. For example, the flagrant gap above bar FIGURE 3: VOLUME SPIKES AND SINGLE BAR BREAKOUTS. The volume spike along with the big black candlestick on April 17, 2003, A provides tremendous rewhich broke the significant support level (blue horizontal line), made the three volume indicators point downward. The price is also below sistance. the 200 period simple moving average. Is this a sell signal? At point B, where another volume spike appeared, price failed to break above the L1 level but broke down Avery Dennison 200-period simple moving average below the short-term resistance L3, pushing all those who bought at B into the wall. This move gave the first indication that a further decline could lay ahead (small blue down arrow). Chaikin money flow But this is not a strong signal — note the question mark above the arrow — Chaikin A/D due to a couple of reasons. For starters, L3 is a very short-term support and just OBV below L3 is the bar A level: L4. Volume-spike bars (such as A) provide great Volume support/resistance (remember the sentiment factor discussed previously). FIGURE 4: DAILY CHART OF AVERY DENNISON (AVY). The threshold level defined by the low of the high-volume black candlestick on When prices broke below April 17, 2003 (red horizontal line), didn’t break and it acted as a vaulting horse that moved the price higher. L4 (second small blue downward arrow), it was a more solid sell signal than the first one. Because prices de- that there was another volume spike and prices broke below L2. clined for a while after bar A on low volume but remained This was the final strike to all bulls that bought at all three spikes. above L2, it suggests that those who bought at A may be willing to take the risk to sustain their posit ion for as long as L2 is not SPIKES AND BREAKOUT CONFIRMATION broken. So using L2 as a threshold level would be less risky. In Figure 3, you see a daily chart of Avery Dennison (A VY). The strongest sell signal came after bar C. At C, you can see Below the price chart are three volume indicators as well as Copyright (c) Technical Analysis Inc.
Stocks & Commodities V. 23:6 (30-37): Spike Up The Volume by Giorgos Siligardos, Ph.D.
volume. A 200-period simple moving average is A also overlaid on the price B chart. On April 17, 2003, GEK price declined sharply, forming a large black candle accompanied by a very high volume spike. All volume indicators (Chaikin money flow, Chaikin A/D, and OBV) turned downward and Chaikin A/D took extremely low negative values. The black candle also broke out of a significant support level (blue horizontal line). OBV All factors (simple moving average, volume indiVolume cators, breakdown of support level) point to an extremely bearish situation, except the volume spike, which just indicates that FIGURE 5: DAILY CHART OF GEK. Price advanced quickly and stalled at bar A near a previous resistance level (blue horizontal line). The most significant signal came after prices broke below the short-term support line (red horizontal line). something is going on. Though the closing price of April 17, 2003, is well below the support level of 52 (blue OBV and Chaikin A/D indicated a possible decline ahead, and horizontal line), this support level is broken by only one bar. at bar B, Chaikin A/D and O BV diverged. From these bars, you Does this mean the break is not meaningful? This question can cannot predict if the trend is going to reverse. The clear sell only be answered after the subsequent bars have formed. signal (blue downward arrow) came only after the short-term The black candle (including shadows) that appeared on support line (red horizontal line) was broken. April 17, 2003, had a relatively large range so the high and low could be used as the threshold levels. Looking at the informa- CONCLUSION tion on the chart, only the threshold level (short red horizontal Volume reflects the amount of participation at a price level and is line) defined by the low (or slightly below) of the blac k candle something that can be thought of as direction-neutral. When you can be considered significant. see spikes in volume, they can create ambiguous signals and An ideal sell signal would be generated if this threshold were distort price and volume-based indicators. In spite of that, volume broken after a pullback to the previous broken support line. So spikes are useful since they pinpoint important price levels. So what really happened? If you look at Figure 4, you can see that when interpreted properly, they can provide extra information and the price level did not break below this threshold. This means the explain future price behavior. If you consider signals from volume breakout was a false one. Further, prices used this support level spikes as alerts, they can be thought of as leading indicators. If, on as a vaulting horse for moving upward (see blue upward arrow). the other hand, you consider volume spikes as directional signals, they can be thought of as lagging. To clear the misty landscape, GLOBAL APPLICATION you must use price movement that follows the spike in conjuncIn Figure 5 you see a chart of GEK Group (GEK) and subcharts tion with the past price and volume performance. of Chaikin A/D, OBV, and volume. G EK is a holding company trading in the Athens Stock Exchange of Greece. I chose this Giorgos Siligardos teaches in the department of applied example to show that the general interpretation of volume mathematics at the University of Crete. He also teaches at the spikes discussed in this article can be globally applied. Two department of finance and insurance in the Technological very tall volume spikes are clearly identi fied in the chart (bars Institute of Crete. A and B). The spikes appeared when price got close to a previous significant resistance (blue horizontal line). RELATED READING At first glance, this situation appears to be more bearish than Nison, Steve [1991]. Japanese Candlestick Charting Techbullish. Rational thinking suggests that traders are probably niques, New York Institute of Finance. unloading shares, but as we saw in the previous examples, this Tomlinson, Andrew [2004]. “A Tale Of Two Indicators,” is only a suggestion and more information is needed. At bar A, Technical Analysis of STOCKS & COMMODITIES , V 22: S&C October. †See Traders’ Glossary for definition Copyright (c) Technical Analysis Inc.
