Volume Indicators: Price Trend, Rate of Change

Volume Price Trend

Volume Price Trend (VPT) was developed by David L. Markstein in 1966 in How to Chart Your Way to Stock Market Profits. It is among many indicators used to determine the relationship between a stock's price and volume. VPT takes the percentage gain or loss on the day and multiplies that by the day's volume, thus considering the amount of force (volume) behind the move. VPT is similar to On-Balance Volume in that it is a cumulative trending indicator, but while On-Balance Volume simply adds or subtracts all of the day's volume to or from the running total, depending on the direction of the close, VPT takes into account the size of the day's gain or loss and multiplies that number by the day's volume.

Formulation

The formula for VPT is as follows:

VPT = yesterday's VPT + {volume x

[(close today — previous close) / previous close]}

When VPT rises, money is flowing into the market or security being tracked. When VPT falls, money is flowing out of the market or security. If VPT flattens out, it is an early warning sign of a possible trend change. Volume Price Trend is good for confirming trends, showing positive and negative divergences, and confirming breakouts. Chart 9.68 shows a basic plot of Volume Price Trend for the Nasdaq 100 Trust ETF (QQQQ).

Chart 9.68 Volume Price Trend, Nasdaq 100 Trust ETF

Trend Confirmation

Volume Price Trend is a trending indicator that is good for confirming trends or showing divergences. In the example of 3M (MMM) in Chart 9.69, note how VPT confirms the uptrend by making a series of higher highs and higher lows along with price. This showed that buyers were in control, thus confirming the uptrend. Downtrends are also confirmed by the VPT indicator. The example of Intel (INTC) in Chart 9.70 shows how VPT made lower highs and lower lows along with downtrending price, revealing that sellers were in control. A strong downtrending market like this should tell any prospective buyers that it is not a good time to buy until price and VPT stabilize.

Divergences

Volume Price Trend can show when a trend is weakening and getting ready to reverse. The example of JPMorgan Chase (JPM) in Chart 9.71 shows a positive divergence (i.e., a new price low with a higher low in the indicator) that occurred right at the March 2009 bottom. That divergence showed that buyers were stepping up and that the long, sharp downtrend was ready for a reversal higher.

Chart 9.69 Volume Price Trend Confirming Uptrend, 3M Company

Chart 9.70 Volume Price Trend Confirming Downtrend, Intel corp.

Chart 9.71 Volume Price Trend, Positive Divergence and Reversal, JPMorgan Chase

Chart 9.72 shows a negative divergence for the iShares Barclays 7-10 Year Treasury Trust ETF (IEF); IEF rocketed out to a new price high in December 2008, while VPT did not. VPTs inability to make a new high with price showed latent selling, which demonstrated that sellers were dumping IEF on the final break to its December 2008 high.

Confirming Breakouts

Another strength of Volume Price Trend is its ability to confirm price breakouts. If price overcomes a resistance level and moves higher, or if it moves lower through a support level, VPT should confirm the breakout or breakdown by doing the same. If it does not, the breakout or breakdown is suspect. The example of iShares High Yield Corporate Bond ETF (HYG) in Chart 9.73 shows how VPT confirmed the break higher. Confirmation came after the breakout, but the late move higher in VPT validated the price movement.

Downside price breakdowns are also validated by VPT. Notice in Chart 9.74 (the S&P SPDR Financial ETF, or XLF) how VPT confirmed the downside breakout in XLF as the downtrend resumed in September 2008.

 Chart 9.72 Volume Price Trend, Negative Divergence and Reversal, iShares Barclays 7-10 Year Treasury Trust ETF

Chart 9.73 Volume Price Trend Confirming Breakout, iShares High Yield Corporate Bond ETF

Chart 9.74 Volume Price Trend Confirming Breakdown, S&P SPDR Financial ETF

Volume Price Trend with Other Indicators

Since Volume Price Trend is a cumulative trending indicator, it is best paired with an Overbought/Oversold Oscillator to spot buying or selling opportunities within the larger trend.

In Chart 9.75, VPT is paired with a 14-period slow Stochastic (14, 3, 3) for the 3M Corp. (MMM). As with the other trending indicators, VPT will be used as a trade filter, dictating whether buy or sell setups are to be taken. In an uptrend, a buy setup occurs when the VPT is trending higher and the 14-period Stochastic is below 20 (oversold). A buy is executed once the Stochastic crosses above 20 following the setup. In a downtrend, a sell setup occurs when the VPT is trending lower and the 14-period Stochastic is above 80 (overbought). A short sell is executed when the Stochastic crosses below 80. Chart 9.75 contains buy arrows (pointing higher) and a sell arrow (pointing lower) to designate each trade.

Trade Setup

In the example that follows, we will use VPT to look for a sign that an uptrend is ready to resume. Chart 9.76 shows the powerful uptrend that began for the iShares Russell 2000 Index ETF (IWM) in October 2006

Chart 9.75 Volume Price Trend Paired with 14-Day Slow Stochastic, 3M Corp.

Chart 9.76 Volume Price Trend, Positive Divergence and Trade Setup, iShares Russell 2000 Index ETF

and continued through May 2007. Price then reversed and corrected into July 2007, giving rise to the positive divergence. Note how price came back down to its mid-June low as VPT made a higher low. That indicated weaker selling pressure on the test of the June low. A resistance line could be drawn across the June-August tops. Price closing above this line gave a signal to enter a long position.

Trade Entry

As Chart 9.77 shows, price closed above the resistance line on August 29, 2006, giving a buy signal. The two higher reactionary lows after the July 21 low allowed an opportunity to use a stop closer to the trade entry point. If the low of August 24 had been penetrated, that would have been a sign that another trip down near the June-July lows would be in order, thus signaling that the close above the resistance line was a false breakout. The moral of the story: Never take any signal for granted on any trade, no matter how great a setup looks.

Chart 9.77 Volume Price Trend, Positive Divergence and Trade Entry, iShares Russell 2000 Index ETF

Trader Tips

Volume Price Trend is an indicator that can show when buyers or sellers are in control or if control is shifting from one group to the other. VPT is commonly used for the following:

• Confirming price trends
• Showing divergences
• Confirming price breakouts

One drawback to VPT is that it does not take into account the quality of the close of each trading day. For example, a close below the open and at the bottom of its daily range is counted as all positive as long as the close is above the previous day’s closing value.

Volume Rate of Change

The Volume Rate of Change (VROC) is a technical indicator used to gauge the volatility in a security's volume. The higher the volatility, the stronger the conviction of the side that is moving the market (either buyers or sellers). VROC can give an indication as to whether resistance or support levels are likely to be broken. It can also provide information as to whether a trend is developing or resuming.

Formulation

The Volume Rate of Change is calculated as follows:

Volume ROC = [(volume - volume n periods ago) /

volume n periods ago] X 100

Volume Rate of Change is most commonly used to identify short-term trend changes in the market, trend continuation, and breakouts. Anytime volume characteristics change, traders need to take notice. Volume Rate of Change illustrates these changes. Essentially, the indicator reveals the percentage change in the volume over the last n periods. If the volume is higher than the previous period, then the rate of change is positive; conversely, if it is less than its previous period, then the rate of change is negative. This indicator can thus reveal the speed or momentum of the change in volume and, in many ways, the strength of the volume trend.

Chart 9.78 The 10-Period Volume Rate of Change, Nasdaq 100 Trust ETF

One of the issues with the indicator is how to set parameters for its use. For short-term traders, periods of 10 to 15 days, much like the volume moving average, are useful. However, at the same time, the jagged and irregular nature of the indicator can often give a false signal, so care must be taken in its translation. Using intermediate time frames of 25 to 50 gives a more robust and smoothed look to the data. Chart 9.78 shows a plot of a 10-day Volume Rate of Change for the Nasdaq 100 Trust ETF (QQQQ).

Price Change of Direction

Volume Rate of Change can be used for spotting short-term buying climaxes that tend to give way to periods of consolidation and profit taking. There is no indication of how long these periods of consolidation will last, but VROC can alert short-term traders when a pullback may be due. Chart 9.79 shows how spikes in the 10-period VROC for Microsoft (MSFT) coincide with short-term tops in an uptrend. Note how volume spiked at a short-term low in early 2010. That was a change in character for volume that was an early indication that the sellers were gaining control. A decent sell-off followed.

Chart 9.79 The 10-Period Volume Rate of Change, Volume Spikes, and Short-Term Tops, Microsoft Corp.

S&P SPDR Financial ETF (XLF) in Chart 9.80 shows how a 25-day VROC identified short-term change points, in this case both short-term highs and short-term lows. Note how the longer period of 25 days causes a smoother plot in VROC. The spikes on the VROC can indicate that change—one way or another—is near. VROC can also be used to spot longer-term changes in trend. In the S&P 500 Trust ETF (SPY) in Chart 9.81, note how the 50-period VROC (an even longer, more smoothed form of the indicator) nailed the March 2009 bottom with a tremendous spike. That spike showed a change in character in the volume pattern, giving a clue that change was imminent.

Chart 9.82 provides another look at the SPY chart and the March 2009 low, which shows how a shorter-term VROC divergence also gave a clue that a price change was near. As price broke lower to the March 2009 low, the VROC was surprisingly tame compared to the October-November 2008 period. That did not confirm the break lower, giving a clue that the breakdown needed to be watched for signs of a reversal.

Confirming Breakouts

Spikes in the VROC can be used to confirm breakouts. As price enters a resistance area, a new flood of volume is usually necessary to push higher through these areas. The VROC is a great indicator to show a significant

Chart 9.80 The 25-Period Volume Rate of Change, Volume Spikes and Inflection Points, S&P SPDR Financial ETF

Chart 9.81 The 50-Period Volume Rate of Change, Volume Spikes Confirmation of Major Low, S&P 500 Trust ETF

Chart 9.82 The 10-Period Volume Rate of Change, Failure to Confirm Further Breakdown, S&P 500 Trust ETF

volume spike to push prices higher or to drive them lower, depending on the situation. Recall Chart 9.82, which showed how the 10-day VROC for SPY did not confirm the breakdown. In Chart 9.83, note how the 10-day VROC spiked as Intel broke through resistance to higher levels.

Trend Resumption

VROC is also good for identifying when a trend is resuming its previous course. Such a scenario gives good buying opportunities in uptrends as buyers are coming back into the market to drive it higher after corrective phases. Note in the S&P Consumer Select Staples SPDR ETF (XLP) in Chart 9.84 how spikes in the 10-period VROC coincide with short-term bottoms.

Smoothing VROC

To take away some of the volatility and to make peaks and troughs stand out more, VROC can be smoothed into a moving average. Smoothing the VROC can also show zero-line crossovers as an oscillator, showing periods of building or declining momentum.

 Chart 9.83 The 10-Period Volume Rate of Change, Confirming Breakouts, Intel Corp.

Chart 9.84 The 10-Period Volume Rate of Change Confirming Trend Resumption, S&P Consumer Select Staples SPDR ETF

Chart 9.85 Volume Rate of Change, 10-Day Moving Average, Confirming Volume Momentum, S&P Consumer Select Staples SPDR ETF

The reason that VROC isn't classified as an oscillator, however, is that center-line crossovers rarely give clear-cut signals. Also, zero-line crossovers in the VROC have nothing to do with price direction, only the momentum of volume itself. Chart 9.85 is the same time frame of the S&P Consumer Select Staples SPDR ETF (XLP) as Chart 9.84, but this time VROC is smoothed into a 10-day moving average. Note how the peaks and troughs stand out a bit more and also how there are fewer zero-line crosses compared to the raw (unsmoothed) version.

Volume Rate of Change with Other Indicators

Because VROC is a great indicator for marking turning points, a good pairing would be with an Overbought/Oversold Oscillator. As price enters overbought or oversold territory, spikes in the VROC can be used to show that the short-term extreme in price is ready to reverse.

Chart 9.86 shows a 25-day VROC paired with a 10-day Williams %R. As stated earlier, Williams %R is simply a raw Stochastic plotted on an inverse scale. A buy setup occurs when Williams %R enters the oversold zone (less than —80) and VROC spikes higher in relation to its recent

Chart 9.86 The 25-Day Volume Rate of Change with Williams %R Oscillator, S&P SPDR Financial ETF

values. A buy is triggered when the Williams %R crosses up out of the oversold zone (greater than —80). A short-sell setup occurs when Williams %R enters the overbought zone (greater than —20) and VROC spikes in relation to its recent values. A short sell is triggered when Williams %R reverses lower out of overbought territory (less than —20). The S&P SPDR Financial ETF (XLF) in Chart 9.86 shows a breakout on the left-hand side of the chart followed by an assortment of buy and sell signals.

Trade Setup

VROC can give a longer-term look at volume trends when it is set to look at longer time frames. Chart 9.87 shows a divergence between price and volume in the U.S. Dollar Index in the fall of 2008. Note that as price moved higher off its September low, VROC was making lower highs. The decrease in volume is also visible in the plot of volume in the bottom pane of Chart 9.87. With the lack of supportive volume, it was just a matter of patience in waiting for price to violate its uptrend support line and reverse lower.

Chart 9.87 The 25-Day Volume Rate of Change, Negative Divergence Trade Setup, U.S .Dollar Index

Trade Entry

Looking at the same chart in more detail in Chart 9.88, we see that both VROC and volume showed that supportive volume was not present on the move higher off the September 2008 lows; it was just a matter of time before the trend reversed. The violation of the upsloping support line would be the signal that the uptrend was at an end. On November 24, 2008, price closed below its support line, which would have triggered a short trade. The initial protective stop should have been placed over the November 19 high of 89.25. Even more patience was required after applying the trade, however, as price consolidated for nine more trading days before beginning its descent in earnest. Also note how VROC spiked once the selling resumed after the nine-day consolidation period.

Trader Tips

Volume Rate of Change is an indicator that alerts traders to changes in volume characteristics that can indicate imminent changes in price. The VROC can be used for the following:

• Showing when a short-term change of direction is likely

 Chart 9.88 The 25-Day Volume Rate of Change, Negative Divergence Trade Entry, U.S. Dollar Index

• Confirming breakouts over resistance or breakdowns below support
• Showing when trend resumption out of a pullback is likely

One drawback of VROC, especially in raw or unsmoothed form, is that its volatile nature sometimes can make it misleading.