118 sil

Copyright (c) Technical Analysis Inc.

Stocks & Commodities V. 23:6 (30-37): Spike Up The Volume by Giorgos Siligardos, Ph.D.

by Giorgos Siligardos, Ph.D.

V

A long spike appearing in the volume histogramusually catches your attention. But how do thesespikes in volume really affect indicators and prices?

INDICATORS

Leading Or Lagging?

that means it’s attracting a large number of buyers orsellers. Oftentimes, this huge rush leads traders awry.

In his article “A Tale Of Two Indicators,” AndrewTomlinson gave an interesting example of two vol-ume indicators that diverge, giving opposite signals.The daily volume spike along with a gapping downhammer created these signals, and Tomlinson notedthat this divergence was due to the nature of theformulas of these volume indicators. Here I willdiscuss the concept of volume and show that volumespikes actually do not provide signals that indicatewhich way prices will go, but rather provide instan-taneous alert signals.

THE TWO-FACED BUS THEORYOne of the basic guidelines of classic technical analy-sis is that bullish periods need high volume to con-tinue, whereas bearish periods could continue with-out the need of high volume. Moreover, when thevolume starts to fall in a bull market, it suggests thata bearish market is near. An analogy from physics isa “two-faced” bus, like those airport buses with twodriver’s seats used to transfer passengers and person-

Spike Up The Volume

nel, moving up and down a hill. The bus representsthe tradable, the height of where the bus is on the hillrepresents the price of the security, and the tradingvolume represents the fuel of the bus. When the fuelstarts to diminish, the bus may stop advancing andfall back due to its weight and the laws of gravity. Ifthe bus driver wants to go down the hill and hasenough fuel, he or she may step on the gas pedal andthe descending acceleration will be much strongerthan the natural acceleration of the gravity. Thissimulates the idea that bear markets accompanied byhigh volume are extremely severe.

The two-faced bus theory also models consolida-tion periods with diminishing volume. This is whenthe bus runs out of fuel and needs to wait until its fueltank is filled again. Only after the fuel tank is filledcan the bus decide where it wants to go.

How are volume spikes represented in this model?By a sudden filling of the fuel tank. When thishappens, the bus may travel a long way in thedirection it wants. As soon as the fuel tank is sud-denly filled, the will of the bus (if it had a will) — notunlike an 18-year-old boy with a brand-new car filledwith gasoline — instantaneously becomes unpre-dictable (which may be the reason why many oscil-lator developers advise not to use oscillator signalsaccompanied with high volume). Let us explore thissituation further using a common-sense approach.

SENTIMENT FACTOR AND VOLUME NEUTRALITY

In his Japanese Candlestick Charting Techniques,candlestick expert Steve Nison asks a rhetoricalquestion: “What is the most significant price level fora trader/investor on any chart?”

Though this question seems to be quite general,Nison’s answer is disarming: “The most significantprice level for a trader/investor is the price level at

olume can be considered to be the fuelof the markets. When the daily tradingvolume of a security is extremely highcompared to its average daily values,


Stocks & Commodities V. 23:6 (30-37): Spike Up The Volume by Giorgos Siligardos, Ph.D.BE

LLA

DO

WN

S



which he/she entered themarket. People becomeemotionally attached to theprice at which they boughtor sold.” Nison used this ar-gument to explain the senti-ment factor that makes sup-port/resistance levels impor-tant, the implications of theirbreakouts, and the changeof polarity principle (that is,broken support becomes re-sistance and broken resis-tance becomes support).

This argument could beextended further: Since themost significant price fora trader is the price atwhich he/she entered aposition, you could saythat the most significantprice level for a security isthe level considered mostsignificant by the major-ity of traders — that is, theprice levels at which high trading volume takes place.

It wouldn’t be prudent to extract immediate conclusionsfrom a price bar with high volume without knowing at least alittle of the movement that follows this bar. The rationale forthis is hidden in the direction neutrality of volume (also notedby Tomlinson). While a price movement can be classified bydefinition as bullish or bearish, volume itself cannot be classi-fied as bullish or bearish. Bulls buy the security expecting togain profit. Bears sell the security expecting to gain profit.Who is right?

The bulls, as much as the bears, may have opposite opinionsabout the market, but they all try to gain profits and they allagree on the price level that they buy/sell the security. Volumesimply represents the number of all agreements without bias.A high-volume bar just says, “I am significant because there ismuch hope or despair in me.” But it is the movement thatfollows the high-volume bar that will indicate who will finallybe right. If the price drops after the high-volume bar, it meansthe bears are right. If the price rises after the high-volume bar,it means that the bulls have the upper hand.

But a new problem now arises: How much movement isneeded after the appearance of the volume spike to pinpoint theright direction? There is no certain answer to this question, butconsidering the sentiment factor at support and resistancelevels, you’ll find that there will often be a breakout of a short-or medium-term support/resistance after the high-volume barthat can be used to indicate the direction of prices.

Volume spikes provide leading alert signals and laggingdirection signals. I will show you three examples where youwill see the usefulness, or lack thereof, of volume indicatorsand how volume-spike analysis could provide more confident

First Energy Corp.(Utilities)

Chaikin A/D oscillator

On-balance volume

Volume

A

B

and firm signals to save you from false breakouts. I will alsoshow, through another example, that volume spike analysiscan be applied in almost all markets.

VOLUME INDICATORSAND INCONSISTENCYLet’s look at an example simi-lar to the one that Tomlinsonused in his article. In Figure 1you see a daily chart ofFirstEnergy Corp. (FE). Thereare also three subcharts show-ing the performance of Chaikinaccumulation/distribution

(Chaikin A/D), on-balance volume (OBV), and volume itself.Three vertical white lines are added for visual clarity. It is clearthat the gapping down day (bar A) had a terrible effect on bothChaikin A/D and OBV. OBV gave a sell signal and Chaikin A/Dgave a buy signal. What happened next? Chaikin A/D starteddeclining and indicating that it was perhaps not a good idea tobuy in the first place. OBV, on the other hand, started advanc-ing, showing that it was perhaps not a good idea to sell in thefirst place. Then another volume spike appeared (bar B), andboth indicators screamed “Buy”! But after that, in spite ofprices and OBV continuing to advance, Chaikin A/D starteddeclining, suggesting a bearish situation was near.

From this you could conclude that OBV was more consis-tent, but what if someone had followed its first sell signal afterthe downward breakout at bar A? The downward OBV move-ment at bar A broke a historical support level of OBV, which

FIGURE 1: WHO IS RIGHT? On the daily chart of First Energy Corp. (FE) the volume indicators diverge at bar A, giving ambiguous signals.

MET

ASTO

CK



made the sell signal evenstronger from the perspec-tive of classic technicalanalysis. This is an exampleof how relying on the be-havior of volume indica-tors at volume spikes as di-rection signals creates noth-ing more than confusion.

But if you consider theirbehavior as an alert, you’llsee that signals are moreconsistent. In this example,both indicators were cor-rect. They were both (eachin its own way) sayingthe same thing: “Some-thing is going on here!”But most people interpretan instantaneous upwardmovement of an indicatoras a buy and a downwardmovement as a sell.

SPIKES, SENTIMENT,AND RATIONAL THINKINGLet’s look at this example from the perspective of senti-ment. A gapping-down white candle occurred at point Awith very high volume. Because of the appearance of thewhite candle, basic technical analysis suggests this is bull-ish for the short term and bearish for the long term (becauseof the downward gap).

After the formation of the gap, it is reasonable to expectprices to test the upper level of the gap before declining to newlows. But volume spikes make things complicated and you needto see how things will proceed before you act. At this stage(based only on the information shown), a closing price slightlybelow the low of the white candle (bar A) could be considereda possible sell signal. But as you can see from the chart, priceadvanced and stopped above the upper boundary of the gap afterA. Then you were confronted with another unexpected pricemovement. Another big white candle (bar B) appeared, accom-panied by a volume spike, similar to the previous one.

Here is where things become interesting. Since the gap isnow filled, it is my guess that you are slightly more bullish thanbearish but still not sure because of the high-volume bar B.However, you could consider two levels to give you directionsignals. You could consider the low (or slightly below) of thewhite candle (bar B) as a support level which, when broken,will give a sell signal with a first target of 25.82 (the low of barA). You could also consider the high (or slightly above) of thewhite candle (bar B) as a resistance level which, when brokenup, will give a buy signal. These two threshold levels areillustrated as red horizontal lines in Figure 1. The upperthreshold was crossed approximately 10 bars later and as canbe seen, it was a solid signal (blue arrow). The small pullbacks

Great Plains Energy Inc.

Chaikin A/D

OBV

Volume

A BC

?L3

L1

L2L4

?

after that (small downward red arrows) did nothing more butmake the buy signal even more confident.

Now, take a look at the two spikes and their implications.The first spike implied a reversal, and the second spike implieda continuation. But you can’t really be sure who bought or soldat bar B. All you can do is suspect that those who sold at bar Bwere of two kinds: Those who had not sold before the first gapdown and now have an opportunity to break even, or those whobought at bar A and wanted to lock in their profits. In any case,the buyers proved to be right.

A SECOND EXAMPLEIn Figure 2 you see a daily chart ofGreat Plains Energy (GXP) alongwith Chaikin A/D, OBV, and vol-ume. Here again I have added ver-tical black lines for visual clarity.You can clearly see three volumespikes at bars A, B, and C. If you

consider the behavior of the OBV at these points as a signal, youwould have been thrown off course. The same thing wouldhave happened if you had also considered the behavior of theChaikin A/D as a signal at bars B and C. At least in thisexample, both volume indicator signals suggest the samedirection at B and C.

Again, the behavior of the indicators at the spikes is notincorrect if they are considered to be alerts for a significantevent (considering the general volume behavior outside thosespikes). Nor are volume indicators useless all the time. It is thespikes that distort the regular movement of volume indicators

FIGURE 2: DAILY CHART OF GREAT PLAINS ENERGY INC. Chaikin accumulation/distribution and on-balance volume give ambiguoussignals at high volume bars A, B, and C.



that there was another volume spike and prices broke below L2.This was the final strike to all bulls that bought at all three spikes.

SPIKES AND BREAKOUT CONFIRMATIONIn Figure 3, you see a daily chart of Avery Dennison (AVY).Below the price chart are three volume indicators as well as

and provide ambiguous di-rection signals. For ex-ample, from bar A to bar B,OBV supported the upwardprice move and indicatedthe correct direction. Buthow can you get reason-able and more solid signalsusing the information fromthe spikes?

In this case, at bar A youcould use level L1 as athreshold for a buy signaland level L2 as a thresholdfor a sell signal — that is, aclosing price above L1 orone that is below L2 is thetrigger. You don’t want toset a threshold level that istoo close to bar A because itcould be risky. For example,the flagrant gap above barA provides tremendous re-sistance.

At point B, where anothervolume spike appeared,price failed to break abovethe L1 level but broke downbelow the short-term resis-tance L3, pushing all thosewho bought at B into thewall. This move gave thefirst indication that a fur-ther decline could lay ahead(small blue down arrow).

But this is not a strongsignal — note the questionmark above the arrow —due to a couple of reasons.For starters, L3 is a veryshort-term support and justbelow L3 is the bar A level:L4. Volume-spike bars(such as A) provide greatsupport/resistance (re-member the sentiment fac-tor discussed previously).When prices broke belowL4 (second small bluedownward arrow), it was amore solid sell signal than the first one. Because prices de-clined for a while after bar A on low volume but remainedabove L2, it suggests that those who bought at A may be willingto take the risk to sustain their position for as long as L2 is notbroken. So using L2 as a threshold level would be less risky.

The strongest sell signal came after bar C. At C, you can see

Avery Dennison 200-period simple moving average

Chaikin A/D

Chaikin money flow

OBV

Volume

FIGURE 3: VOLUME SPIKES AND SINGLE BAR BREAKOUTS. The volume spike along with the big black candlestick on April 17, 2003,which broke the significant support level (blue horizontal line), made the three volume indicators point downward. The price is also belowthe 200 period simple moving average. Is this a sell signal?

Avery Dennison200-period simple moving average

Chaikin A/D

Chaikin money flow

OBV

Volume

FIGURE 4: DAILY CHART OF AVERY DENNISON (AVY). The threshold level defined by the low of the high-volume black candlestick onApril 17, 2003 (red horizontal line), didn’t break and it acted as a vaulting horse that moved the price higher.



volume. A 200-periodsimple moving average isalso overlaid on the pricechart. On April 17, 2003,price declined sharply,forming a large black candleaccompanied by a very highvolume spike. All volumeindicators (Chaikin moneyflow, Chaikin A/D, andOBV) turned downward andtook extremely low nega-tive values. The blackcandle also broke out of asignificant support level(blue horizontal line).

All factors (simple mov-ing average, volume indi-cators, breakdown of sup-port level) point to an ex-tremely bearish situation,except the volume spike,which just indicates thatsomething is going on.Though the closing price ofApril 17, 2003, is well below the support level of 52 (bluehorizontal line), this support level is broken by only one bar.Does this mean the break is not meaningful? This question canonly be answered after the subsequent bars have formed.

The black candle (including shadows) that appeared onApril 17, 2003, had a relatively large range so the high and lowcould be used as the threshold levels. Looking at the informa-tion on the chart, only the threshold level (short red horizontalline) defined by the low (or slightly below) of the black candlecan be considered significant.

An ideal sell signal would be generated if this threshold werebroken after a pullback to the previous broken support line. Sowhat really happened? If you look at Figure 4, you can see thatthe price level did not break below this threshold. This means thebreakout was a false one. Further, prices used this support levelas a vaulting horse for moving upward (see blue upward arrow).

GLOBAL APPLICATIONIn Figure 5 you see a chart of GEK Group (GEK) and subchartsof Chaikin A/D, OBV, and volume. GEK is a holding companytrading in the Athens Stock Exchange of Greece. I chose thisexample to show that the general interpretation of volumespikes discussed in this article can be globally applied. Twovery tall volume spikes are clearly identified in the chart (barsA and B). The spikes appeared when price got close to aprevious significant resistance (blue horizontal line).

At first glance, this situation appears to be more bearish thanbullish. Rational thinking suggests that traders are probablyunloading shares, but as we saw in the previous examples, thisis only a suggestion and more information is needed. At bar A,

AB

GEK

Chaikin A/D

OBV

Volume

FIGURE 5: DAILY CHART OF GEK. Price advanced quickly and stalled at bar A near a previous resistance level (blue horizontal line).The most significant signal came after prices broke below the short-term support line (red horizontal line).

OBV and Chaikin A/D indicated a possible decline ahead, andat bar B, Chaikin A/D and OBV diverged. From these bars, youcannot predict if the trend is going to reverse. The clear sellsignal (blue downward arrow) came only after the short-termsupport line (red horizontal line) was broken.

CONCLUSIONVolume reflects the amount of participation at a price level and issomething that can be thought of as direction-neutral. When yousee spikes in volume, they can create ambiguous signals anddistort price and volume-based indicators. In spite of that, volumespikes are useful since they pinpoint important price levels. Sowhen interpreted properly, they can provide extra information andexplain future price behavior. If you consider signals from volumespikes as alerts, they can be thought of as leading indicators. If, onthe other hand, you consider volume spikes as directional signals,they can be thought of as lagging. To clear the misty landscape,you must use price movement that follows the spike in conjunc-tion with the past price and volume performance.

Giorgos Siligardos teaches in the department of appliedmathematics at the University of Crete. He also teaches at thedepartment of finance and insurance in the TechnologicalInstitute of Crete.

RELATED READINGNison, Steve [1991]. Japanese Candlestick Charting Tech-

niques, New York Institute of Finance.Tomlinson, Andrew [2004]. “A Tale Of Two Indicators,”

Technical Analysis of STOCKS & COMMODITIES, V 22:October.†See Traders’ Glossary for definition S&C

118 sil

Documents