Volume Based Technical Analysis
Introduction into Advance/Decline Volume Analysis
Volume is a trusted indicator of the market sentiment. Only volume can indicate a period of intense buying (greedy buying) and intense selling (panic selling). Volume-based technical indicators are leading indicators. They reveals future movements in price before they happen. Volume indicators do not simply reveal overbought and oversold levels. They signal when the supply/demand changes its flow by causing price to change direction.
Volume Breadth indicators constitute one of the group of volume-based indicators that carry advance/decline information, as well as volume information. Since the advance/decline data can be received only from the basket of stocks, advance/decline volume indicators can be applied only to the indexes and exchanges.
Advancing stocks are those stocks that are traded above the previous trading day close price. Declining stocks are the stocks that are traded below the previous trading day close price. Advancing volume is the total volume of all advancing stocks and declining volume is the total volume of all declining stocks.
Here are the four most-used technical indicators based on advance/decline volume data:
- The Advance/Decline Volume Ratio
- The Advance/Decline Volume Oscillator
- The Advance/Decline Volume Line
The Advance/Decline Volume Ratio
The Advance/Decline volume ratio is calculated as the ratio of advancing volume to declining volume:
A/D Volume Ratio = (Advancing Volume) / (Declining Volume)
Advance/decline volume ratio readings above one signal that the traders are focusing more on trading advancing stocks. A/D volume ratio values between zero and one indicate that the majority of traders are focused on the declining stocks. This indicator is used in technical analysis to spot overbought and oversold levels. Thus, very high A/D volume Oscillator readings (and higher) indicate an overbought market and very low readings (below 10) indicate an oversold market.
The Advance/Decline Volume Oscillator
The advance/decline volume oscillator is constructed as the difference between advancing and declining volume:
A/D Volume Ratio = [(Advancing Volume) - (Declining Volume)]
Like the A/D volume ratio, the A/D volume Oscillator enables you to spot oversold and overbought levels. The difference is that, while the A/D Volume Ratio operates with absolute values, the A/D volume Oscillator represents the actual volume flow and oscillates around the zero line.
In addition to identifying oversold and overbought levels, both the Advance/Decline Volume Oscillator and the Ratio are used in technical analysis to track money flow and measure bearish and bullish volume accumulation. Since these indicators are based on volume data, the same principles that are applied to the SBV Oscillator, Chaikin Money Flow (CMF), and Volume Accumulation Oscillator (VAO) can be applied to them.
The Advance/Decline Volume Line
The advance/decline volume line is constructed as the cumulative difference between advancing and declining volumes:
A/D Volume Ratio = Σ[(Advancing Volume) - (Declining Volume)]
The advance/decline volume line is used less in technical analysis than the ratio and oscillator. Due to its cumulative nature, it is difficult to use this indicator to define overbought and oversold levels. Nevertheless, this indicator can be used to define the money flow and is an excellent barometer of market sentiment.
The TRIN is based on the advance/decline issues and volume data. The TRIN formula is:
TRIN = (AD Issues Ratio)/(AD Volume Ratio)
or to put it more specifically:
TRIN = (Advancing issues/declining issues) / (advancing volume/declining volume)
The combination of advance/decline issues and volume data in the TRIN analysis allows you to more precisely monitor sentiment changes. TRIN is considered to be a better indicator for shorter-term trends than the A/D ratio or the Oscillator.
NEXT: Mid-Term Analysis
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