Unlocking the Secrets of Volume Analysis for Smarter Investing
Volume analysis is the examination of the number of shares or contracts of a security that have been traded in a given period. This method is used extensively by technical analysts as one of the many factors that inform their trading decisions. By analyzing trends in volume alongside price movements, investors can determine the significance of changes in a security’s price.
Key Takeaways
- Volume analysis involves examining relative or absolute changes in an asset’s trading volume to infer future price movements.
- Market strength indicator: Rising markets with increasing volume are generally seen as strong, while falling prices with rising volume suggest a strengthening downward trend.
- Various tools, such as the Positive Volume Index (PVI), use volume data in technical analysis.
Understanding Volume Analysis
Volume analysis plays a crucial role for all types of analysts following specific securities in financial markets. Generally, volume refers to the number of shares transacted per day. Understanding the entire market’s trading volume versus the volume of a single holding offers significant insights that assist analysts in discerning volume trends.
High volumes of trading can reveal crucial insights into investors’ outlooks on a market or security. For example, a significant price increase accompanied by a significant volume increase could be a credible sign of a continued bullish trend or a bullish reversal. Conversely, a significant price decrease with a significant volume increase may suggest a continued bearish trend or a bearish trend reversal.
Incorporating volume into daily charting diagrams can be essential for technical analysts. Volume charts are typically displayed below a standard candlestick graph and often include moving average trendlines.
Incorporating volume into a trading decision provides a more balanced view of the broad market factors influencing a security’s price, contributing to more informed investment decisions.
Volume Indicators
In technical analysis, two popular indicators specifically use volume to aid investors. The Positive Volume Index (PVI) and Negative Volume Index (NVI), developed by Paul Dysart in the 1930s, became notably popular in 1975 when they were discussed in Norman Fosback’s book, “Stock Market Logic.”
PVI and NVI are both calculated based on the previous day’s trading volume and a security’s market price. When trading volume increases from the previous day, the PVI is adjusted accordingly. Conversely, when trading volume decreases from the previous day, the NVI is adjusted. These index calculations show how volume affects price movements.
When PVI rises or falls, it suggests price changes driven by high volumes. Conversely, an increase or decrease in NVI indicates price changes with minimal volume influence.
Calculating the Positive Volume Index (PVI)
If current volume is greater than the previous day’s volume, PVI is calculated as follows:
1PVI = PVI_{previous} + \
2\left(\frac{CP_{today} - CP_{yesterday}}{CP_{yesterday}}\right) \
3∗ PVI_{previous}
Where:
- PVI_{previous} is the previous PVI
- CP_{today} is today’s closing price
- CP_{previous} is the previous closing price
If the current volume is lower than the previous day’s volume, PVI remains unchanged.
Calculating the Negative Volume Index (NVI)
If the current volume is less than the previous day’s volume, NVI is calculated as follows:
1NVI = NVI_{previous} + \
2\left(\frac{CP_{today} - CP_{yesterday}}{CP_{yesterday}}\right) \
3∗ NVI_{previous}
Where:
- NVI_{previous} is the previous NVI
- CP_{today} is today’s closing price
- CP_{previous} is the previous closing price
If the current volume is higher than the previous day’s volume, NVI remains unchanged. Many investors consider noise trading a significant factor in the Positive Volume Index; thus, the Negative Volume Index is often followed for its insights into professional traders’ market activity.
Related Terms: Trading Volume, Technical Indicators, Positive Volume Index, Negative Volume Index.
