EQUI-VOLUME AND ON BALANCE VOLUME

By Daryl Guppy

EQUI-VOLUME

Running along the bottom of a price chart display is a line of vertical bars. This is a volume display. Each bar shows the total trading volume for the day. We always assume that volume has an important relationship with price behavior. When we try to pin this down, the relationship is more difficult to establish. Some charting methods try to match price and volume. We look at the equi-volume display this month. Equi-volume plots were developed by Richard Arms and detailed in Volume Cycles in the Stock Market. Next we look at some technical indicators that try to understand volume and price. It is easy to make general statements about price and volume. When price increases on high volume we know the market crowd is eager to buy stock and demand exceeds supply. Falling prices are driven rapidly lower on high volume as the crowd dumps the stock. The equi-volume chart display attempts to understand this demand and supply relationship by making volume an equal partner with price. Many charting programs automatically complete the calculations and show the display. The equi-volume display at first glance resembles a Darvas chart, but with boxes of various sizes. The top line of the box is the high for the day, and the bottom line the low as shown in the KL Kepong chart extract.

The chart display includes fat squat boxes and long thin rectangles. The width of the box represents the volume traded for the day. The width of each equi-volume box is based on a percentage of the total volume displayed on the entire chart. If the chart displays 100 days with a combined total volume of 100,000, then the size of each equi-volume box is determined by the normalized volume value. This divides the actual volume for the day by 100,000 in this example. The width of each box is a percentage of this 100,000. On the next day the total volume displayed changes to perhaps 120,000, but only 100 days are shown. The oldest day is dropped off and the newest day is added to the display to keep the display length consistent at 100 days. This changes the percentage relationships, and alters the width of pre-existing boxes. No longer is the chart directly comparable to yesterdays chart, or the chart plotted three weeks ago. The problem remains even when the chart starting date remains fixed. Now the total volume is 120,000 but 101 days are shown. Traders use the equi-volume displays to identify some specific relationships. Short and wide boxes show small changes in price, but very heavy volume. These squat large boxes usually appear at turning points. At the bottom of a down trend these show steady accumulation of shares. Experienced investors are buying quality at discount prices. At the top of a trend, the same pattern of squat boxes shows a steady distribution of shares. Traders and investors are slowly selling, or unwinding, their positions to people who are less informed. On a bar chart this shows up as a resistance level. The addition of volume information supplies extra information about the nature of the resistance. Traders look for power boxes where both height and width increase substantially. When these boxes appear above a resistance level they signal a well sustained breakout. Thin boxes starved of volume suggest these breakouts are poorly supported. This is a significant way to verify other charting signals, such as the breakout from an up sloping triangle. Volume feeds the market, and equi-volume plots provide a useful way to capture the relationship in a single chart display.

Traders believe that volume tells us something important about price and trends. We believe that significant moves in volume indicate trending activity and point the way to major changes in the direction of the trend. The On Balance Volume (OBV) indicator is a useful way to track changes in volume behaviour. OBV was developed by Joe Granville in his book New Strategy of Daily Stock Market Timing for Maximum Profits. The indicator starts from the observation that the direction of the price trend is confirmed if the trend in volume moves in the same way. This indicator tracks the buying and selling pressure. Buying pressure keeps a trend rising, while selling pressure keeps a trend falling. The indicator works by examining each days trading. If the close is higher than the open then the volume of that day is calculated on the bullish side of the calculation. If the price is falling, then the volume for the day is added to the bearish side of the calculation. The level of volume is not important. Some days only a few lots may be traded, but of the prices continue to rise then this is bullish. On other days a rising price may be accompanied by very high volume. The OBV indicator tracks all the volume associated with rising or falling prices. The calculation starts at zero with the first day of price data, perhaps 10 or 15 years ago. The indicator displays the accumulated balance of volume over this period. What is important is the direction of the indicator line, not the actual volume figure. Perhaps there are 20000 lots traded on the first day when prices rise. The starting figure is 20000. The next day is a falling day, but only 10000 lots are traded. This figure is subtracted from the starting fire, leaving a value of 10000. On day three 30000 lots are traded as prices close higher for the day. This figure is added to yesterday figure to give 40000. The value of each previous day is used as a starting point and new figures are either added or subtracted depending on the direction of the price change. The result is an on balance volume calculation. Different counters have different levels of volume so we cannot use the absolute on balance volume figure in this indicator. Instead traders look for the direction of the OBV display. The first signal in a confirmation signal. Rising prices are confirmed by a rise in the OBV value and this suggests trend strength. When there’s strong and increasing buying pressure, the price is almost certain to continue going up. The theory is that money from knowledgeable traders, or smart money, can be seen flowing into the security when the OBV value rises.

Confirmation signals are interesting, but traders usually want advance warning signals. They obtain these in three ways from the OBV indicator. The first comes when we apply a moving average to the OBV indicator. A 10 day moving average is commonly used, but many traders experiment with this value. The advance warning of a trend change comes when the OBV line moves above or below the 10 day moving average line. The second type of advance trend change warning signals comes from divergence. This is the same signal used with oscillator indicators such as the Relative Strength Index. Trend lines can be applied to the OBV indicator. When the trend line moves in the opposite direction to the trend line placed on a price chart the trader has early warning of a potential trend change. Some traders also use trend line breakouts on the OBV indicator as an early warning of a change on the price chart. The advantage of the OBV indicator is the way it matches the trend and momentum of volume with the trend in prices. One weaknesses of the OBV indicator is that an entire day’s volume is assigned a plus or minus value.