Volume Spread Analysis

[karthikmarar]

Friends

For me TA is a passion. I have been experimenting a lot on various aspects of TA. It has been a good learning experience. Sharing my experiments was a bigger learning experience. Truly, unlike sharing money sharing knowledge only leads to further expansion of knowledge.

A few months ago I came across a thread on Volume spread Analysis in the Traders laboratory forum. Though I did not understand much the seeds of interest were sown. Thus began a new chapter in my TA journey.

I had posted some charts based on my work on this. A few had shown interest on this especially our esteemed Asish. So we will begin a discussion on the Volume Spread Analysis. I request other knowledgeable members to add their bit to this discussion so that we have fruitful learning experience.

Calling VSA as advanced strategy may be controversial. But the concept is rather new and is gaining wide popularity. Hence we will consider it as advanced strategy.

Regards

karthik

Note: As we know this will be a restricted thread. Those who cannot post their doubts can still posts queries in my other threads and genuine queries would be answered there. Good post even will be copied on the main thread. Now that the awareness on the reputation points has grown, we hope more members will be able to post in this thread.

 

[karthikmarar]

Some background notes..

Once the seed of interest were sown hours were spent searching the net and watching clips on Youtube. The journey was full of obstacles. There was hardly any clear cut information available. Most were sales talks with sketchy information. Then hours were spent studying the charts and formulating rules. The rules were coded to check the validity of these rules. Some Traderji friend stepped in and there were some real time checks for these rules. Thus we came up with our own interpretation of the Volume spread analysis.

Please do not start comparing my description with the ones that may be available from the net. I have used some basic stuff from Tom Williamss book and have built on it. Here we are not trying to clone the Trader Guider system.

 

[karthikmarar]

What is Volume Spread analysis?

Volume spread analysis is a new way of looking at the market. It more like the candlestick analysis taking into consideration the volume. However not all the candle stick rules apply here.

The basic premise behind the volume spread analysis is that the market is basically moved by the Smart Money. The smart money accumulates the stocks at low prices. Then begins process of marking up the price. Then the Dumb Money starts entering the smart slowly. The smart money starts passing the ownership of the stocks to the dumb money. This process is called Distribution. Soon more and more dumb money starts rushing into the market not wanting to be left out of the big rally. Unfortunately the retail traders are the last to get in. Once the process of distribution is complete the smart money starts rapidly marking down the prices and the dumb money are left holding the stock which was bought at high prices. At the end the smart money is much richer and they can again start accumulating the stock at lower prices. The cycle continues.

This one way explains why the move moves are slow and the down moves are very rapid. The process of marking up the prices and distribution is a slow process. It takes some effort to get the dumb money interested in buying into the rally. The mark down process is very rapid as the smart moneys intention is to trap the dumb money. They have to give very little chances to dumb money which is generally slow in reacting to exit.

VSA attempts to read the moves of the smart money by looking at the price, volume and the spread of prices.

 

[uasish]

My Input for the Uninitiated New guys to Technical Analysis as Karthik proceeds with the build up phase:=
..................................................................................................................
[VSA may not be advanced to many but obviously another approach of how to utilise Volume information vis-a-vis Price.]

Traditional approach if Price increases along with higher volume then (+)ve or Price decreases along with higher volume then (-)ve.

It was the era of OBV,in the sixties.(On Balance Volume)
Joseph Granville, creator of the On Balance Volume indicator, insisted on the importance of volume analysis. He exclaims that volume precedes price, and he even goes so far as to argue that volume is cause and price is effect.

Then traders made few more observations on Volume :=
a)Traders must always look at price patterns in conjunction with their associated volume pattern, never alone. A stock may appear to be in a head and shoulders pattern, but the volume pattern must confirm that analysis.

b)Careful analysis of the volume of selling that occurred above current resistance will help you estimate how long a stock will stall at that level.

c)Well-above-normal volume is essential when separating a true from a false breakout above resistance.

d)Well-above-normal volume on the break of a key support level is likely to keep the swing trader from making the mistake of shorting into a deceptive "spring" formation.

e)Climactic volume can occur after a sustained downtrend. The retest of the support level of the selling climax can provide a good trading opportunity if it is accompanied by low volume (as compared to the selling climax).

Like these enters VSA = Volume Spread Analysis (Though the person behind this Tom Williams has taken the concept from a Richard Wykoff of 18th century & built upon it.)
Which Karthik has taken a Gr8 effort to explain to us.(I am personally keen to know)

There is also another New Approach "Profile".
Developed by "J.Peter Steidlmayer"
Steidlmayer conceived these tools from 1981 to 1983 while serving a three-year term on the CBOT’s board of directors.

 

[beginner_av]

Just a slight clarification for newbies. Market Profile plots Time per Price, while the commonly available Volume Profile plots Volume per Price. Distinction is for conceptual clarity only. after that you can use VP properly to get readings "similar" to MP and use VPOC too.

 

[Czar]

but is there any way to negate the artificially created volume, like say the minute & 5 minute may indicate just a large trade done but hourly daily will not indicate the same, like if there was a way to differentiate artificially generated volume from the ones done on supports & resistances area in the bigger picture...

you see in live market here in India I see lot of artificial volume created by circular trading... so the question.

for eg. in a recent market I saw hugh volume in Siemen on breaking the low of the day in hourly, but when I tried to see in the tick by tick, it showed that the volume was not done when it broke the low but later in 1 single trade on recovering...

 

[karthikmarar]

The foundations for volume spread analysis were laid by R.Wyckoff way back in the early 1930s. Wyckoff was supposed to have made fortunes with his principles. Wyckoff stared with a premise that price / volume / Time could provide a picture of the demand and supply from smart money (he called the smart money ‘composite man’). We will come back Wyckoff later in the thread. It would be nice to look at Wyckoff methods time to time as his work is the basic one and others have built on it.

Wyckoff had three basic principles or..say.. laws

Supply and Demand
Cause and Effect
Effort and Result

The current day VSA available in the market still relate to these tenets.

Much later in the 70s Tom Williams who worked with a syndicate (read… Smart money) for 15 years, developed on the Wyckoff’s work and came up with Volume Spread Analysis and later commercialized it. (The critic would say ..why commercialize it, he could have made money himself.. ). Now many more companies offer their own concoction of VSA, hawkeye traders and genie software to name a few.

Tom William’s VSA basically ignores the open of a bar and uses high, Low and Close. This is where it basically differs from classical candlestick analysis. Most commercial vendors claim to use more than 300 indicators to analyze each bar. I have seen that some of the VSA vendors use other indicators though not explicitly.

One thing is certain that the availability of basic information on VSA is scarce. I have come across much discussion on other forums on VSA. However most revolve around commercially available packages. Our intention in this thread will be to explore the basics so that each one of us can arrive at our own convenient VSA analysis.

 

[karthikmarar]

Now it is time to move on .

I know most of you are eager to get straight into the core of VSA. But let us lay some foundations before building the blocks of VSA. First thing is of course to understand a little more about working of Smart Money (hereafter we will just use the term SM to indicate Smart money).

The SM basically moves the market in four phases as follows

1. Accumulation
2. Markup
3. Distribution
4. Mark Down

Most of you may be fully aware of these. Still we will look at these phases more in details as this would help us to understand the SM operation better which in turn would give a better perspective to VSA.

There will not be any demand for something when there is plenty of it available and nobody wants it. As the availability decreases and more people want it then the demand increases. So the first thing the SM does is find something that is available a plenty and cheap. The next step is to create a scarcity of the same and get people interested in it which in turn generates the demand. This is first phase which is Accumulation.

Accumulation is a process through which the SM acquires a large quantity of the stock at the lowest possible price. Accumulation is a subtle, sophisticated and sly process of cornering a huge quantity of the stock that makes the following phases possible and worthwhile. Once a large quantity has been absorbed the number of floating stock reduces and the demand increases. This makes possible the next phase Markup.

Accumulation normally takes place in congestion areas. Congestion area are mostly sideways range bound movements where the stock appears to have no interest to either move up or move down. The SM ensures that the stock is contained below a certain upper level which is the supply area. At the same time the SM also supports the prices above a certain lower line which is the support area. The stock moves within an upper resistance or supply area and a lower support area.

The congestion areas are characterized by Indecision. One of the most important characters of congestion areas is the Low Volume. When most traders are bullish or bearish the volume is high. Low volumes indicate indecision among the traders on bullishness and bearishness.

Ah.. Sounds easy.. Well the problem is that congestion areas are seen in both accumulation areas as well as Distribution areas oh , Well that is not the only problem. There will be periods where no one seems to be interested in the stock the pattern of price movement most of time very similar to the congestion pattern..

So the naturally the question is how one would ascertain if the pattern is really accumulation in progress. A little later on this and other congestion patterns..

 

[karthikmarar]

So the question was How one checks if the congestion area is really an accumulation area.


There are a few things to lookout for..

First, the indecision should be quite visible. In other words the volume should be low and quite. No huge volume upsurges. Even if the volume is relatively higher the range between up day volumes and down day volume should be narrow.

Second, the spread of the bars (High Low) should be narrow.

Third, the volume should shrink near the support line and expand near the resistance line.

Fourth, the stock should be trading in a range for some weeks if not months.

Also you may see some shakeouts in the trading range. The SM would temporarily drive down the prices below the support line in order to takeout the stop losses and panic the weak hands into selling. You will see the stock bounces back above the support line immediately. By this process the SM is shaking out the weak money from the stock. For most of us it is just a failed breakout. Sometime the stock instead of bouncing back would continue to drop if there was too much supply. So trading these breakouts could be tricky.

Also it would a good sign if the stocks trading range is much above the support line.

Normally we would see some of the above signs if not all in the acuumulation area.

There are many other patterns which signify accumulation. Some of them are rounding bottoms, reverse head and shoulder and double bottoms (or W) patterns. Each could be explained in terms of SM activity. However we would go into the details now. One thing to keep in mind when evaluating patterns is that it is very important to check the volume pattern as well.

For an example we will look at the chart of HCC where a clear accumulation indication was seen June 2007...

 

[karthikmarar]

A few points about the congestion zone we are looking at for signs of accumulation. It is important to look at the history of the stock prior to the congestion area.

A few things to look out for.

Has the stock gone through a cycle of accumulation, markup, distribution and markdown previously? Were there signs of a selling climax just prior to the congestion? If so, the SM are really looking out for making another round.

Or the stock has been languishing aimlessly prior to the congestion zone you are looking at. If so, this area you are looking at is not accumulation at all.

Was the stock enjoying an uptrend prior to the congestion? If so, this could be a re-accumulation going on here.

Was the stock undergoing a minor down trend (after an up move) prior to the congestion? Was there a downtrend without selling climax? Then this could mean there is re-distribution in progress and it may be advisable to look out for sign of distribution.

(If you are wondering what is selling climax.. dont worry.. we will take it up in detail later.)