Volume Indicators

Based on a PVO (Percentage Volume Oscillator) level of 14% (click HERE to read about it), we can create a simple trading system, as follows:

• Assume the S&P 500 index is moving higher and building up a volume surge. Then, once the PVO has reached a level equal to or greater than 14% for at least 2 consecutive days (ignore first PVO high for a given volume surge), get ready to short (however, please note that we ignore the first PVO high associated with a surge - see details below). Sell short once the PVO starts to decline from this high level; 
• Assume the index has reversed from its previous up-move and is now starting to push lower. If you see a volume surge develop during this down-move, and the PVO reaches a level above 13%, then cover your short position; 
• Assume the index is pushing lower and building up a volume surge. Then, once the PVO has reached a level equal to or greater than 14% for at least 2 days (ignore first PVO high for a given volume surge), get ready to go long. Initiate your long position once the PVO starts to decline from this high level; 
• Close out your long position once the PVO has reached a level above 13% in conjunction with a volume surge to the price up-side.

If you are in position and the market does not reverse it's direction and the PVO starts to rise again, you may wish to add to either the long or to the short position.

Very important: Ignore VMA surges (i.e., PVO highs) if they occur immediately after the index reversal has just occurred. Volume surges at this point simply confirm that a reversal has taken place. Do not trade based on these surges.

Table 1 below shows a number of simulated trades that are based on the system we outlined above.

Some PVO trading examples (please refer to Table 1):

• September, 2005: The (5/25) PVO hit a value of 15% while the index created a VMA surge to the price upside; however, no trade was initiated at this point, because it was the first PVO high. A similar situation occurred on September 23, 2004: We noted a VMA surge while the index was declining. On this day, the (5/25) PVO reached its highest level of 14%, but no trade was initiated because it was the first PVO high for this particular surge.
• October 4 to 6, 2004: As the index moved higher and created a large VMA surge to the upside, the (5/25) PVO exceeded and remained above the critical level of 14% for three consecutive days. We ignored the first PVO high on October 4, 2004; the decision to go short was made after the PVO started to decrease on October 7, 2005. This trade was closed on October 21, 2004 when a (5/25) PVO) high of 13% was reached while the index was in decline.
• December 17 to 21, 2004: While the index was trending higher and generating a volume surge in December 2004, a (5/25) PVO high was reached and maintained for three consecutive days. In accordance with our trading rules, the first PVO high (which occurred on December 17) was ignored. The decision to go short was then made on December 21, 2004 when the PVO started to decrease. The trade was subsequently closed on January 25, 2005: As the index declined, it created a volume surge and a new (5/25) PVO high occurred.
• January 25 to 27, 2005: As the index declined during this time, a volume surge built up. We noted a (5/25) PVO high for three consecutive days. The decision to take a long position was reached on January 27, 2005, when we noted the PVO decrease from its high of 16%. The following day - on January 28, 2005 - the index reversed and started to push higher, gaining ground through to February 1. The PVO peaked again, but we ignored this signal since it simply confirmed that an index reversal had taken place on January 27. We have not yet seen a confirming VMA surge that would prompt us to close out this trade.
• April 18 to 21, 2005: During this time, a high  (5/25) PVO value was maintained over four consecutive days during the price decline. On April 21, 2005, the PVO started to decrease, so a decision to take a long position was made. To date, we have not seen a high PVO value that would have prompted us to close out this trade.

Conclusion:

• The trading system outlined above is highly conservative. It generated only four signals per year. The success rate of the system is very high - there were no losing trades. If you plan to trade according to this system, and perhaps modify some the parameters, we would suggest incorporating a reasonable stop loss strategy in order to protect your capital (one such way would be to use a trailing stop). 
• Given the short-term nature of the system, you could use it to trade options on the underlying; suggested are options that expire within 2 to 3 months. 
• The system could benefit from the inclusion of pre-determined profit levels;

The system parameters we used in the above examples do not necessarily represent the optimal settings. Should you decide to follow our strategy, we would recommend that you define your own critical PVO levels (PVO Quotes).

Disclaimer: The above research results are provided for educational purposes only. If you wish to apply any of the numbers, systems, or strategies discussed in this article, you should understand that you are doing so at your own will and that you are solely responsible for any trading decisions you make.

Copyright 2004 - 2005 Highlight Investments Group. All rights reserved. This material may not be published, broadcast, rewritten, or redistributed

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