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On-Balance Volume (OBV) Indicator

On-balance volume (OBV) is a technical trading momentum indicator that uses volume flow to predict changes in stock price.

It was developed by Joseph Granville and introduced in his 1963 book Granville’s New Key to Stock Market Profits.

Granville believed that volume was the key force behind markets and designed OBV to predict major moves based on volume changes.

He described OBV as akin to “a spring being wound tightly,” where a sharp increase in volume without a significant price change would eventually lead to a price jump upward or downward.

Formula for On-Balance Volume (OBV)

The formula for OBV is:

OBV = Previous OBV + {volume, if the close is higher than the previous close, if the close is the same as the previous close −volume, if the close is lower than the previous close}

Where:

  • OBV is the current on-balance volume level.
  • Previous OBV is the OBV from the prior day.
  • Volume is the latest trading volume amount.

Calculating On-Balance Volume

OBV provides a running total of an asset’s trading volume, indicating whether the volume is flowing in or out of the security.

There are three rules for calculating OBV:

  1. If today’s closing price is higher than yesterday’s, the current OBV = Previous OBV + today’s volume.
  2. If today’s closing price is lower than yesterday’s, the current OBV = Previous OBV – today’s volume.
  3. If today’s closing price is equal to yesterday’s, the current OBV = Previous OBV.

What Does OBV Tell You?

OBV is based on the distinction between institutional investors (“smart money”) and less sophisticated retail investors.

When institutions start buying an asset, volume may increase even if the price remains stable.

Eventually, volume pushes the price upward as larger investors sell and smaller investors buy.

The OBV indicator itself is cumulative, and traders focus on its movement over time rather than its numerical value.

The slope of the OBV line is key for analysis, tracking volume numbers to signal potential opportunities for buying or selling.

Example of How to Use OBV

Consider a stock with 10 days of closing prices and volumes:

  • Day 1: Price = $10, Volume = 25,200 shares
  • Day 2: Price = $10.15, Volume = 30,000 shares
  • Day 3: Price = $10.17, Volume = 25,600 shares

On days where prices rise, volumes are added to the OBV, and on down days, volumes are subtracted.

The OBV values over the 10 days would be as follows:

  • Day 1 OBV = 0
  • Day 2 OBV = 30,000
  • Day 3 OBV = 55,600

OBV vs. Accumulation/Distribution

While OBV and the accumulation/distribution (Acc/Dist) line are both volume-based indicators, they differ in their calculation.

OBV adds or subtracts volume based on whether the price closed higher or lower.

Acc/Dist uses the position of the current price relative to its recent trading range, multiplied by the volume.

Limitations of OBV

  1. OBV is a leading indicator and can produce false signals due to its predictive nature.
  2. A large spike in volume on a single day (e.g., due to a surprise earnings announcement) can throw off the OBV for a long period.
  3. To reduce the likelihood of false signals, OBV is often used with lagging indicators such as moving averages.

Concluding Thoughts

On-balance volume (OBV) is a valuable technical indicator that measures volume flow to predict price direction.

While it offers insights into market sentiment and potential price movements, OBV should be used in conjunction with other indicators to confirm its signals and avoid false interpretations.

Balancing OBV with lagging indicators can provide a more comprehensive view for making informed trading decisions.

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Volume-Weighted Average Price (VWAP)

The volume-weighted average price (VWAP) is a technical analysis indicator used on intraday charts that resets at the start of each new trading session.

It represents the average price at which a security has traded throughout the day, taking into account both price and volume.

VWAP is important because it provides traders with insight into both the price trend and the value of a security.

Understanding the Volume-Weighted Average Price (VWAP)

VWAP is calculated by summing the dollars traded for each transaction (price multiplied by volume) and then dividing that by the total shares traded.

Formula

The formula for VWAP is:

VWAP = (Cumulative Typical Price × Volume) / Cumulative Volume

Where:

  • Typical Price = (High Price + Low Price + Closing Price) / 3
  • Cumulative = Total trades since the trading session opened

How to Calculate VWAP

Although adding the VWAP indicator to a streaming chart automates the calculation, here’s how to calculate it manually.

  1. Determine the average price the stock traded at during the first five-minute period of the day. Add the high, low, and close, then divide by three. Multiply this by the volume for that period, and record the result in a spreadsheet under “PV” (price and volume).
  2. Divide PV by the volume for that period to get VWAP.
  3. Continue adding the PV value from each period to the prior values and divide the total by the total volume up to that point to maintain the VWAP throughout the day.

How Is VWAP Used?

Traders use VWAP in various ways.

They may treat it as a trend confirmation tool, considering prices below VWAP as undervalued and prices above it as overvalued.

For instance, if a stock price moves above VWAP, traders may go long on the stock, and if it moves below, they may sell or go short.

Institutional buyers also use VWAP to minimize market impact by trying to buy below VWAP or sell above it, ensuring their actions don’t artificially move the stock price.

VWAP vs. Simple Moving Average

VWAP and simple moving average (SMA) may look alike on a chart, but they differ in calculation.

VWAP incorporates both price and volume, while SMA only incorporates price.

The SMA is calculated by averaging the closing prices over a specific period, while VWAP accounts for volume-weighted prices.

Limitations of VWAP

  1. VWAP is a single-day indicator that resets each day, making it difficult to use over extended periods.
  2. While useful, VWAP should not be the only factor considered, as in strong uptrends, waiting for prices to fall below VWAP could result in missed opportunities.
  3. VWAP is based on historical values, making it a lagging indicator with increasing lag as the day progresses.

What Does VWAP Tell You?

VWAP helps traders gauge liquidity and the price at which buyers and sellers agree.

It offers insight into price movement throughout the day and can guide trading decisions.

Why Is the Volume-Weighted Average Price Important?

VWAP provides a smoothed view of a security’s price, adjusted for volume, helping institutional traders execute orders without significantly affecting the stock’s price.

For example, a hedge fund may avoid buying above VWAP to prevent inflating the price or selling below VWAP to avoid dragging down the price.

Is VWAP a Leading Indicator?

No, VWAP is a lagging indicator since it uses historical data.

It is valuable for specific uses, but it does not offer real-time insights for traders seeking up-to-the-minute data.

Concluding Thoughts

VWAP is a valuable tool in technical analysis for determining the average price of a security during a single trading session.

While useful for tracking intraday price trends and liquidity, it is a lagging indicator best utilized in conjunction with other tools for more comprehensive market analysis.

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What are Volume Indicators for Trading?

Volume refers to the total amount of a security or item that is traded over time, typically within a trading day.

For instance, the number of shares exchanged between a stock’s daily open and close is known as its trading volume.

Technical traders rely heavily on key information like trading volume and changes in volume over time to make informed decisions.

Importance of High Volume

High volume signals increased interest in the stock, indicating the active presence of buyers and sellers.

When a stock is in an uptrend and volume increases, this suggests that the stock will continue rising, as more buyers are interested in acquiring it.

Similarly, when a stock is in a downtrend and volume increases, it signals that the stock will continue declining, as more sellers are looking to offload it.

This behavior can be clearly seen in the daily chart of Reliance Ltd., where rising volumes lead to increasing stock prices.

Importance of Low Volume

Low volume indicates a lack of interest in the stock.

When a stock is moving up but volume decreases, it suggests that buyers are losing interest, potentially signaling a reversal of the uptrend.

Similarly, when a stock is declining and volume drops, it implies that sellers are losing interest, possibly indicating a reversal of the downtrend.

Price Volume What is Expected
Up Up Bullish
Up Down Caution – weak hands buying
Down Up Bearish
Down Down Caution – weak hands selling

Types of Volume Indicators

  1. On-Balance Volume (OBV): OBV is a cumulative indicator that sums up volume on up days and subtracts volume on down days. It helps gauge buying and selling pressure.
  2. Volume RSI: Similar to the Relative Strength Index (RSI), Volume RSI uses up-volume and down-volume to provide trading signals based on crossovers around the 50% center line.
  3. Volume Price Trend (VPT) Indicator: VPT assesses both price direction and the strength of price changes, helping traders confirm trends or detect divergences between price and volume.
  4. Money Flow Index (MFI): This indicator measures trading pressure using both price and volume, and is similar to RSI but volume-weighted.
  5. Chaikin Money Flow (CMF) Indicator: CMF evaluates market strength by measuring money flow volume over a period, typically 20 to 21 days, and can help confirm breakout directions.
  6. Accumulation/Distribution Line: This indicator tracks the cumulative flow of money into or out of a stock, helping identify divergences that signal future price movements.
  7. Ease of Movement (EMV): EMV measures how easily a stock price moves between levels based on volume trends, often used in volatile markets.
  8. Negative Volume Index (NVI): NVI focuses on days with declining volume, assuming that smart money is active on those days, and can indicate bull or bear markets.
  9. Volume-Weighted Average Price (VWAP): VWAP shows the average price of a security throughout a session, incorporating both price and volume, helping traders assess whether a security was bought or sold at a fair price.

Concluding Thoughts

Volume analysis is a critical aspect of technical trading, providing insight into market trends and potential reversals.

By using volume indicators like OBV, VWAP, and MFI, traders can enhance their ability to interpret price movements and refine their trading strategies.

Understanding the relationship between price and volume is essential for making informed decisions in the stock market.

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Ichimoku Kinko Hyo Cloud Indicator

The Ichimoku Cloud is a collection of technical indicators that show support and resistance levels, as well as momentum and trend direction.

It does this by taking multiple averages and plotting them on a chart.

It also uses these figures to compute a “cloud” that attempts to forecast where the price may find support or resistance in the future.

The Ichimoku Cloud was developed by Goichi Hosoda, a Japanese journalist, and published in the late 1960s.

It provides more data points than the standard candlestick chart.

While it seems complicated at first glance, those familiar with how to read the charts often find it easy to understand with well-defined trading signals.

The Formulas for the Ichimoku Cloud

The following are the five formulas for the lines that comprise the Ichimoku Cloud indicator:

Conversion Line (tenkan sen) = (9-PH + 9-PL) ÷ 2
Base Line (kijun sen) = (26-PH + 26-PL) ÷ 2
Leading Span A (senkou span A) = (CL + Base Line) ÷ 2
Leading Span B (senkou span B) = (52-PH + 52-PL) ÷ 2
Lagging Span (chikou span) = Close plotted 26 periods in the past

Where:
PH = Period high
PL = Period low
CL = Conversion line

How to Calculate the Ichimoku Cloud

The highs and lows are the highest and lowest prices seen during the period—for example, the highest and lowest prices seen over the last nine days in the case of the conversion line.

Adding the Ichimoku Cloud indicator to your chart will do the calculations for you, but if you want to calculate it by hand, here are the steps:

  1. Calculate the Conversion Line and the Base Line.
  2. Calculate Leading Span A based on the prior calculations. Once calculated, this data point is plotted 26 periods into the future.
  3. Calculate Leading Span B. Plot this data point 26 periods into the future.
  4. For the Lagging Span, plot the closing price 26 periods into the past on the chart.
  5. The difference between Leading Span A and Leading Span B is colored in to create the cloud.
  6. When Leading Span A is above Leading Span B, color the cloud green. When Leading Span A is below Leading Span B, color the cloud red.

The above steps will create one data point.

To create the lines, as each period comes to an end, go through the steps again to create new data points for that period.

Connect the data points to each other to create the lines and cloud appearance.

What Does the Ichimoku Cloud Tell You?

The technical indicator shows relevant information at a glance by using averages.

The overall trend is up when the price is above the cloud, down when the price is below the cloud, and trendless or transitioning when the price is in the cloud.

When Leading Span A is rising and above Leading Span B, this helps to confirm the uptrend, and the space between the lines is typically colored green.

When Leading Span A is falling and below Leading Span B, this helps confirm the downtrend.

The space between the lines is typically colored red in this case.

Traders will often use the Ichimoku Cloud as an area of support and resistance depending on the relative location of the price.

The cloud provides support/resistance levels that can be projected into the future.

This sets the Ichimoku Cloud apart from many other technical indicators that only provide support and resistance levels for the current date and time.

Traders should use the Ichimoku Cloud in conjunction with other technical indicators to maximize their risk-adjusted returns.

For example, the indicator is often paired with the relative strength index (RSI), which can be used to confirm momentum in a certain direction.

It’s also important to look at the bigger trends to see how the smaller trends fit within them.

For example, during a very strong downtrend, the price may push into the cloud or slightly above it temporarily before falling again.

Only focusing on the indicator would mean missing the bigger picture that the price was under strong longer-term selling pressure.

Crossovers are another way that the indicator can be used.

Watch for the conversion line to move above the base line, especially when the price is above the cloud.

This can be a powerful buy signal.

One option is to hold the trade until the conversion line drops back below the base line.

Any of the other lines could be used as exit points as well.

The Difference Between the Ichimoku Cloud and Moving Averages

While the Ichimoku Cloud uses averages, they are different than a typical moving average.

Simple moving averages take closing prices, add them up, and divide that total by how many closing prices there are.

In a 10-period moving average, the closing prices for the last 10 periods are added, then divided by 10 to get the average.

Notice how the calculations for the Ichimoku Cloud are different.

They are based on highs and lows over a period and then divided by two.

Therefore, Ichimoku averages will be different from traditional moving averages, even if the same number of periods are used.

One indicator is not better than another; they just provide information in different ways.

Limitations of Using the Ichimoku Cloud

The indicator can make a chart look busy with all the lines.

To remedy this, most charting software allows certain lines to be hidden.

For example, all of the lines can be hidden except for Leading Span A and Leading Span B, which create the cloud.

Each trader needs to focus on which lines provide the most information, then consider hiding the rest if all of the lines are distracting.

Another limitation of the Ichimoku Cloud is that it is based on historical data.

While two of these data points are plotted in the future, there is nothing in the formula that is inherently predictive.

Averages are simply being plotted in the future.

The cloud can also become irrelevant for long periods of time, as the price remains way above or way below it.

At times like these, the conversion line, the base line, and their crossovers become more important, as they generally stick closer to the price.

Concluding Thoughts

The Ichimoku Cloud is a versatile tool for traders, providing information on support and resistance levels, trend direction, and momentum at a glance.

While it may initially seem complex, its well-defined trading signals make it accessible once understood.

However, like any technical indicator, the Ichimoku Cloud has its limitations, particularly when used in isolation.

It is most effective when combined with other indicators and risk management strategies to create a well-rounded approach to market analysis.

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Stoller Average Range Channel (STARC) Bands

Commonly called STARC Bands, Stoller Average Range Channel Bands, developed by Manning Stoller, are two bands applied above and below a simple moving average (SMA) of an asset’s price.

The upper band is created by adding the value of the average true range (ATR), or a multiple of it.

The lower band is created by subtracting the value of the ATR from the SMA.

The channel created by the bands can provide traders with ideas on when to buy or sell.

During an overall uptrend, buying near the lower band and selling near the top band is favorable.

STARC bands can provide insight for both ranging and trending markets.

The Formula for Stoller Average Range Channel (STARC) Bands

STARC Band + = SMA + (Multiplier × ATR)
STARC Band – = SMA − (Multiplier × ATR)

Where:
SMA = Simple moving average, with length typically between five and 10 periods
ATR = Average True Range
Multiplier = Factor to apply to ATR – two is common but can be adjusted for personal preference

How to Calculate STARC Bands

  1. Choose an SMA length. Five to 10 periods are common for STARC Bands.
  2. Choose an ATR multiple. Two times ATR is common, although this can be adjusted as needed.
  3. Calculate the SMA.
  4. Calculate the ATR, and then multiply it by the multiple chosen.
  5. Add the ATR x multiple to the SMA to get STARC Band+.
  6. Subtract the ATR x multiple from the SMA to get STARC Band-.
  7. Calculate the new values as each period ends.

What Do STARC Bands Tell You?

STARC bands are a type of envelope channel that provides potential support and resistance levels.

The top band is considered to show the security’s resistance price level, and the bottom band is considered to show the security’s support price level.

The basic trading strategy is to sell when the security’s price is near the resistance band and buy when the security’s price is near the support band.

Favor this strategy when the price is in an overall uptrend or when the price is ranging.

When the price is in an overall downtrend, favor shorting near the upper resistance band and covering near the lower support band.

One thing to be aware of is that the price can move along a band for extended periods of time.

This may mean a trade that looks good at the moment could turn out to be quite poor as the price continues to move along the band.

For example, imagine selling a long position when the price reaches the upper band, only to watch as the price and upper band continue to move higher for some time.

Traders can use various average true range multipliers to influence the width of the bands.

The larger the multiple, the wider the bands.

The smaller the multiple, the tighter the bands.

Longer-term traders may prefer wider bands, while shorter-term traders may prefer narrow bands to potentially catch more trading opportunities.

Difference Between STARC Bands and Bollinger Bands®

STARC bands and Bollinger Bands® are similar in that they create bands around a simple moving average.

STARC bands add and subtract an ATR multiple to form the bands.

Bollinger Bands® add and subtract a standard deviation multiple to form the upper and lower bands.

The interpretation of the bands is similar, but the calculations are different.

Therefore, the two indicators will look slightly different on a chart.

Limitations of Using STARC Bands

While STARC bands can be used to signal potential trading opportunities near the bands, the main problem is that the bands are always moving.

Buying near the lower band may look good, but if the lower band and price keep dropping, then the signal provided was poor.

This will happen frequently, as the price will reach a band, but then the band keeps moving in that direction.

To help remedy this issue, utilize stop losses when taking trades near the bands, as this will help control risk if the price keeps moving against the position.

Also, instead of taking profits when the price reaches a band, consider a tight trailing stop loss instead.

This allows for the price to continue moving along the band, which increases profit.

If the price does reverse, a profit is still locked in.

Concluding Thoughts

STARC bands can be a useful tool in technical analysis, providing traders with insight into potential support and resistance levels in both trending and ranging markets.

However, traders should be cautious of the limitations, as the moving bands can lead to poor signals if the price continues to move in the direction of the band.

Combining STARC bands with other technical indicators and using stop-loss strategies can help traders maximize their profits and manage risk effectively.

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