Volume Based Technical Analysis
Volume Moving Average (VMA)
Volume Moving Average - VMA
A Volume Moving Average is the simplest volume-based technical indicator. Similar to a price moving average, a VMA is an average volume of a security (stock), commodity, index or exchange over a selected period of time. Volume Moving Averages are used in charts and in technical analysis to smooth and describe a volume trend by filtering short term spikes and gaps.
As a rule, volume can be somewhat turbulent and, due to some large trades ("games" of the large institutional traders), you may see surges here and there. By using a moving average of volume, you can smooth out those single fluctuations in volume so it is becomes possible to evaluate the general direction of the volume (i.e., increasing or decreasing) visually, as well as receiving a numeric representation of the volume trend for further use with other indicators and trading systems.
Similar to the price analysis, there are several types of VMA. One of the most widely used VMAs is a Simple Moving Average applied to the volume that is calculated as the average volume over a specified period of time (number of bars):
Simple VMA(n) = (sum of N volume bars) / N
An exponential VMA is another type of moving average that applies weighing factors to reduce the lag in a simple moving average. It is widely used in analysis as well.
A VMA is the basic and simplest tool in analysis. This indicator could be could be analyzed by itself. At the same time, the majority of more complex volume-based technical studies use VMAs in their calculations. You can see a VMA in Volume Oscillator, PVO, and MVO formulas. Indirectly, a moving average is applied to volume in the accumulation/distribution, Oscillator Chaikina, OBV (On Balance Volume), and Chaikin Money Flow (CMF), etc. Consequently, VMA could be called one of the most important tools for use as in indicators.
One of the basic ways to analyze VMA is to monitor changes in its direction. In general, when the price of a security (stock, index or other commodity) price is moving up and we see a large increase in the VMA, it means that the intensity of bullish (buying) traders is increasing greatly. As soon as the VMA starts to decline after hitting its pick level during a price advance, it is signalling that the number of buying traders has begun to decrease and bearish (selling) traders may take over and reverse the trend downward.
In a similar way, an increase in a VMA during a price decline indicates an increase in the number of traders who are selling in panic. As soon as the VMA starts to move down after being at a high level during the price decline, it is signalling that the number of selling traders has been exhausted and that we may see a change in the mood and trend direction.
In the table below is a list of recommended Volume Moving Average (VMA) settings for various periods that are the best for signaling future market trends.
Table #1: Recommended VMA settings
As with price moving averages, the purpose of selecting a period for moving average is to select the one that will smooth the volume and make it less erratic, although not excessively because stronger smoothing increase lag and may even smooth out the signals.
On the S&P 500 index charts below are charts with a different VMA for the same index and the same period of time.
Chart #1: S&P 500 index chart without VMA.
As you can see on the S&P 500 chart above, while it is still possible to recognize periods of high volume, it is difficult to evaluate volume and see exactly when volume activity began to rise or began to decline. Therefore, it is difficult to generate signals on the above chart without a VMA.
The chart below is similar to the chart above with the only difference that VMA(2) - volume moving average with 2-bar period setting - has been plotted on volume.
Chart #2: S&P 500 index chart with VMA(2)
Now that you can see that the same chart with VMA (chart #2) helps to see all volume movement. It makes it easier to recognize periods of high and low volume activity and to determine when volume activity increases and when it declines. Still, due to the low bar period setting of VMA, the VMA on the chart #2 looks erratic. It still could be difficult to generate signals based on this VMA. In that case, one could increase the VMA period. That should help you to see the most important movements of volume.
Chart #3: S&P 500 index chart with VMA(9)
The nextS&P 500 chart (chart #3) has a 9-bar VMA. Now, when we increased the bar period setting for VMA, it became easier to spot the periods in which volume increases and periods in which it began to decline.
You can clearly see the big volume surge on October 1-2. If you compare chart #2 and chart #3, you will see that, by following the rule to buy when the VMA starts to decline after the volume surge peaked during the price decline, two "Buy" signals will be generated on chart #2 (with the 2-bar VMA). One is on October 1 at the market open and another will be on October 2 at the market open. On chart #3 only, one "Buy" signal will be generated in the middle of the trading session on October 2.
Chart #4: S&P 500 index chart with VMA(20)
The last S&P 500 chart (chart #4) covers the same period of time, but with a 20-bar Volume Moving Average applied to volume. You can see that, with a 20-bar period setting, VMA is very smooth, but the lag between volume and VMA became too great. If, on the chart #3, the "Buy" signal was generated on October 2, then on chart #4 the "Buy" signal would be generated on October 5 (when VMA started to decline). If you further compare charts #3 and #4 you will see that the VMA on chart #3 showed a volume surge on September 24 and would generate the "Buy" signal on September 25 (when the VMA started to decline). However, the VMA on chart #4 over-smoothed this volume surge and missed this signal.
Before starting to use VMA, it is recommend that you experiment with the VMA periods to find the one that best fits your personal trading style, selected time-frame and selected security (stock, index and other commodity).