What are Volume Indicators & How Does it Work? | Espresso

Everything You Need to Know About Volume Indicator

While investing in the stock markets, there are several things that you need to look at. One such factor is the volume of a specific stock being traded at a given point in time. In the stock market, many trade exchanges take place every day. While some investors buy and sell their stocks on the same day, others hold them for a longer period.

Published on 22 March 2023

The study of the number of stocks or futures contracts traded during a specific time is known as volume analysis. This volume analysis is done with the help of volume indicators.

This article will discuss the volume indicators, their types, and their importance in detail. Let’s get started.

What are Volume Indicators?

As the name suggests, volume indicators reflect the number of shares that are being traded at a given point. They are technical tools that can be applied to trading analysis charts. For example, the volume indicator can indicate a stock’s bull or bear power by evaluating the buying vs selling power on it.

In other words, a volume indicator measures how many buyers and sellers are interested in a share at a specific point and uses this data to determine the price movements of that share.

Importance of Volume Indicators

Volume indicators work like trend indicators. They help determine the current trend as far as price movements of stocks are concerned. In addition, volume indicators can help you in the technical analysis of stocks and confirm the trends and patterns derived from other methods.

As an investor, you can apply volume indicators to know how many shares are being traded in the stock market at a given point and gauge the overall perception of the investors about the market.

One of the benefits of using the volume indicator is that it can lead you to the price movements in a stock. It can give you early signals of whether the current trend in a stock’s price movement will continue or reverse.

How Do Volume Indicators Work?

Volume indicators indicate the perception of investors about a specific stock by measuring the number of traders that are interested in buying or selling it at a given point. If it indicates a negative perception, it means that the price of a stock can decline shortly, and it can show a bearish pattern. On the other hand, if investors are positive about a stock, its price can go up, and it can show a bullish pattern soon.

For example, if the volume indicator is showing exceptionally high volume for a share compared to its moving average volume, it can be due to euphoria or fear. If the buyers are in high volumes, it reveals euphoria, and if the sellers outnumber the buyers, it reveals fear. Similarly, a much lower volume than the average moving volume can reflect apathy or disinterest among the investors. These emotions can impact the short-term price movements of a stock.

You can also conduct price vs volume analysis to identify the momentum or reversal of a trend. If the price of a stock starts to increase at low volumes, it can mark the beginning of a bullish trend. Similarly, if the price of a stock starts declining at high volumes, it can indicate the likely reversal of the bullish trend and a beginning of the bearish trend.

Types of Volume Indicators

After having understood the importance of volume indicators, let’s know about some common types of volume indicators and their significance:

  • On-balance indicator

The On Balance Volume indicator calculates the cumulative selling and buying pressure on a stock by subtracting the volumes on down days and adding the volumes on up days. The relation between the current trend and the OBV reflects the upcoming price movements.

There are three different scenarios for calculating OBV.

  • When today’s close is higher than yesterday’s close, OBV is calculated by adding Yesterday’s OBV and Today’s Volume
  • When today’s close is lesser than yesterday’s close, OBV is calculated by subtracting Today’s Volume from Yesterday’s OBV
  • When today’s close is equal to yesterday’s close, OBV is equal to Yesterday’s OBV
  • Volume RSI

Volume RSI (Relative Strength Index) works similarly to the RSI indicator except that buying and selling volumes are used in the formula instead of price changes. A volume RSI reading of above 50% indicates a bullish trend, and below 50% indicates a bearish trend.

It is calculated by the following method:

VoRSI = 100-100/(1+VoRS)

VoRS is the ratio between average up volume and average down volume.

  • Money flow index

Money Flow Index (MFI) uses both time and price for measuring the trading pressure on a stock. Therefore, the MFI volume indicator can be interpreted just like the RSI indicator.

The formula for calculating the Money Flow Index is as follows:

  • Firstly, calculate the Typical Price, which is the sum of High, Low and Close divided by 3
  • Secondly, derive the Raw Money Flow which is the Product of Typical Price and Volume
  • Thirdly, find the Money Flow Ratio which is calculated by dividing the 14-period Positive Money Flow by Negative Money Flow
  • Lastly, calculate the Money Flow Index by first multiplying 100 with 1+Money Flow Ratio and subtracting the value from 100.
  • Accumulation distribution indicator

The accumulation distribution indicator measures the cumulative flow of money in and out of the stock. This indicator reflects whether a stock is being accumulated (high buying pressure) or distributed (high selling pressure) at a given point.

The Accumulation and Distribution indicator is calculated based on the following steps:

  1. Money Flow Multiplier = [(Close-Low) - (High-Close)]/(High-Low)
  2. Money Flow Volume = Product of Money Flow Multiplier and Volume for the Period
  3. Accumulation and Distribution(A/D) = Previous value(A/D) + Current Period’s Money Flow Volume
  • Balance of power

Balance of Power (BOP) is a volume indicator that measures the strength of trading pressure on a stock. A reading above zero indicates strong buying pressure, whereas a reading below zero indicates strong selling pressure.

It is calculated by the following few steps:

  1. Step 1: Close price - Open price
  2. Step 2: High price - Low price
  3. Step 3: Step 1/Step 2
  • Volume profile

The volume profile displays the trading activity over a specified period at specified price levels. Volume profile trading can help an investor realise how far a stock is from its value area.

To Conclude

It’s very crucial to consider volume indicators for trade analysis of stocks. Depending upon the frequency of your trades, you should look at the volume indicators at regular intervals. It’s equally important to look at the correlation of these indicators with the current momentum of the market.

 

Chandresh Khona
Team Espresso

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