Volume as a Secondary Indicator according to Dow Theory - Literature review Example

Volume Indicators Volume indicators are a of procedural indicators that use the amalgamation of time and volume to bring about a time series, which exists in formulas. In theory, volume is known to always lead price. As a result, volume aids in the identification of the price of a product through the examination of its volume. Confirmation is vital in the authentication of a break of significant support and confrontation levels, for instance, trend lines, moving averages, and price patterns (Stevens 2002). Dow Theory, which is pegged with volume indicators, is predominantly present in situations that portray a considerable surge in volume, in relation to topical volume. This paper will discuss volume confirmation, taking into account Dow Theory and volume indicators. According to Dow Theory, price fluctuations because of indexes draw attention to the fundamental signs that are applied when making decisions on whether to buy or to sell. Volume, in addition, is applied as a secondary indicator that aids in the confirmation of whether a suggestive price shift is in place. It is, therefore, appropriate to state that volume increases because of price shifts in the direction of the trend. On the contrary, a decrease in volume is noted in instances where price shifts against the trend. For instance, in situations where an uptrend of the price is noted, the volume ought to increase. On the contrary, the prices fall because of decrease in volume. This uptrend signifies power when volume upsurges when traders are presently enthusiastic to buy an asset in the conviction that the growing momentum will persist. During the corrective periods, the low volumes that are experienced signify that numerous traders are afraid to close their positions in the markets. This is because they suppose the low trend momentum witnessed in the market might hold on for a long time (Dormeier 2011). On the other hand, if volume moves in opposite direction to the trend, a weak trend is said to exist. For instance, in situations where the market is noted to be in an uptrend, but the volume fails to move in a similar manner. Such moves signify the beginning of buying dissipation. This could result to the buyers leaving the market or converting into sellers. If such a situation occurs, the chance of an upward trend in the market stands condensed to its minimum. A similar situation exists if volume is increased on days that are considered low (Bishop 1960). This is because more participants are transforming into sellers from buyers in the market scene. Therefore, when putting the Dow Theory into practice, it would be acceptable to state that in a situation where the trend exists confirmed by volume, money in the market ought to be parallel to the trend and not resistant to it. If commercial conditions cause the indexes to move in opposite directions, this results to a difficulty in primary trend development. When trying to substantiate a novel primary trend, as a result, it is vital that the additional (more than one) index extrapolates similar signals contained in moderately close time. If the indexes come to an agreement, it indicates that business environments are heading in the right direction. Thus, it is important to note that mounting indexes point to the development of a new uptrend (Kamich 2003). Since the invention of Charles Dow, the basic principle underlying technical analysis exists as a tune. In situations where stocks change hands, an equal quantification of bought volume to sold volume exists on orders that are executed. The buyers are said to be in control when price is moving up (Kamich 2003). Moreover, the upward movement in price could also signify a reasoned change in demand. On the contrary, the sellers are thought to be in control when the prices move down. As a result, these instances of supply and demand result to accumulation coupled with distribution patterns. Consequently, it is worth noting that Volume Price Confirmation Indicator stood designed to represent the relationship that exists between price and volume as a justification or challenge to the price trends. Volume Price Confirmation Indicator, otherwise known as VPCI, shows the inherent relationships that exist between price and volume. It is worth noting that this relationship exists as a justification or challenge of price trends. As a result, VPCI identifies the intrinsic relationship, connecting price and volume as pleasant or dissonant. Investors who utilize VPCI, more often than not, increase their profits hence resulting into improved dependability among their traders - which often accompanied with the ability to reduce risks. Forces brought about by buyers and sellers in the exchange markets fix prices (Stevens 2002). This is noted to be independent of the differing evaluation of the value of the items being exchanged. The items exchanging hands may be of different values, with one valued higher than the other. However, both goods are equivalent as far as the sale is anxious. Notably, different prices seen in a given market highlight investors’ convictions, emotions and volitions. Therefore, price cannot be constant, but varying. These changes are influenced by information and opinions obtained from the market, which is accompanied with emotions. Market volume, on the other hand, represents the amount of traded shares over a certain period. It is a quantification of contribution, enthusiasm or concentration awarded in a given sanctuary. In any market, price and volume exist intimately linked; nonetheless, they have the capability to be presented as independent variables. Collectively, the variables (price and volume) that are derived individually give improved indications of supply coupled with demand as opposed to what each can avail autonomously. In physics, force exists as a vector magnitude that tends to create an increase of velocity. A similar statement can be equated to market volume, hence it can be considered as the market force. Therefore, force or volume can be equated to the power made effective against support or fight. This is because volume is substantiated and mediated by price. As a result, price is confirmed when volume increases. On the contrary, a decrease in volume leads to contradiction in price movements. In theory, a volume upsurge leads to great movements in price signalling an increase or decrease in the volume (Festa, Atocha and Adriana 2005). Volume indicator confirmation exists measured through a volume oscillator and the use of On Balance Volume (OBV). A volume oscillator quantifies volume by comparing two mobile averages. These two mobile averages are averages of a fast and slow oscillating volume. A histogram is plotted with the difference between the two (a fast and slow moving volume average). It is key to highlight that the two averages differ in the mode of acquisition. The slow moving volume average is acquired within a period of two to three weeks. On the other hand, the fast moving volume average is acquired over a period of 14 days or less (Bishop 1960). The histogram will oscillate above and below the zero line providing the insight into the strength of the price trend. A positive value points out that the market support is enough to provide the foundation needed to push the price towards the current market trend. On the other hand, a negative value suggests that support is lacking, hence prices might become sluggish. In situations where the market exists rallying, the volume oscillator is noted to rise. If overbuying is noted, a reverse of this trend is noted. When the market dwindles, the volume replies by contracting. It is crucial to note that volume measurement is vital in such a situation. An increase in price pegged with a decline in volume is always thought to be bearish. OBV adds volume on up days and deducts on down days hence quantifying buying and selling demands as a snowballing indicator. Developed by Joe Graville, it existed as one of the novel indicators that highlighted positive and negative volume. As a result, it can be used to confirm trends developed by price. OBV upsurges when volume is noted to be more on up days than on down days. It falls when down days volume is noted to be stronger. Positive volume pressure is represented by an increasing OBV. On the contrary, falling OBV translates to a negative pressure exerted by the volume hence reduces the price. As a result, OBV always moves before price. Price charts exist as the foundation for decision making in any market. Therefore, it is noted that several indicators best use these charts. These are trend indicators, money flow indicators, momentum indicators, volatility indicators, and trend channel indicators. Trend indicators endeavour to offer a purpose gauge in relation to the direction of the trend. It is worth noting that the majority of trend indicators liquefy funds relying on ranging markets. This is because narrow price bands tend to make traders lose their positions. It is vital to know the market type (whether it is trending or ranging) (Dormeier 2011). This will aid in the employment of the appropriate indicator. For a trending market, trend indicators are used and for momentum markets, ranging indicators are used. Money flow indicators, also known as MFI, are momentum indicator that analyse the price coupled with the volume hence aid to highlight the certainty in a current trend. As a result, it can be utilized as a quantification of the strength of outgoing and incoming money of a given security. Therefore, it can predict a reversal trend and ranges between 0 and 100. Moreover, it is important to state that MFI is interpreted like Relative Strength Index (RSI) (Festa, Atocha and Adriana 2005). They differ in the fact that while MFI accounts for volume while RSI only includes the price. At its simplest level, momentum is used to indicate the different levels of greed and fear that are experienced in a given market within a specified period. Consequentially, oscillators are used to measure such instances. The dominant leading oscillators direct the securities in the appropriate direction and speed. Therefore, momentum indicators compare prices that are currently in the market in relation to the past prices. Moreover, a momentum indicator records a positive value if the current price is noted to be higher than the previous market price. It is said that the momentum indicator gives a buy signal if it crosses above the zero line. On the contrary, if it falls below the zero line, it indicates a sell signal (Festa, Atocha and Adriana 2005). Vitality indicators confirm prices with the aid of volume. This is specifically in relation to price behaviours that are indicated in the market. The expansion and contraction ranges in the market highlight breakouts and trends respectively. On the other hand, trend channel indicators are used to trail a given momentum of a trend. It is noted that the peaks represent upper channels of the trend and troughs the lower channels of the trends (Sheimo 1989). Conclusion According to Dow Theory, volume exists as a secondary indicator. This is because volume is dependent on the existence and extent of price shifts in the market. On the other hand, VPCI shows the relationship that exists between prices and volume. Therefore, it is dependent on both variables for it to indicate the market trends. Additionally, the volume indicators are measured using volume oscillators and OBV. The specific measurement relies on the most appropriate method in relation to the market and the preference of the analyst. It is noted that these analysts use different types of price indicators to determine the value of volume in the market. Therefore, it is vital that the appropriate price indicators are used to avoid ambiguity and increase reliability of the information to other market players. Works Cited Bishop, George W. Charles H. Dow and the Dow Theory. New York: Appleton-Century-Crofts, 1960. Print. Dormeier, Buff. Investing with Volume Analysis: Identify, Follow, and Profit from Trends. Upper Saddle River, N.J: FT Press, 2011. Print. Festa, Roberto, Atocha Aliseda, and Adriana J. M. Peijnenburg. Confirmation, Empirical Progress, and Truth Approximation. Amsterdam: Rodopi, 2005. Internet resource. Kamich, Bruce M. How Technical Analysis Works. New York: New York Institute of Finance, 2003. Print. Sheimo, Michael D. Dow Theory Redux: The Classic Investment Theory Revised & Updated for the 1990s. Chicago, Ill: Probus Pub. Co, 1989. Print. Stevens, Leigh. Essential Technical Analysis: Tools and Techniques to Spot Market Trends. New York, NY: Wiley, 2002. Print. Read More