TRADING Strategies
(All of the following charts feature five-minute bars.)
F i g u re 2 (top) shows three charts for N o v. 1, 2002. The upper left is up vol-ume, the upper right is down volume and the S&P 500 is on the bottom.
Points Aand B re p resent the pre v i o u s (Oct. 31) close, a day on which down volume was approximately 200 mil-lion more than up volume, and the S & P closed down just less than five p o i n t s .
On the Nov. 1 close (points C and D), however, up volume was more than 1 billion shares and down vol-ume was less than 400 million shares.
It’s no surprise, then, the S&P 500 was up more than 15 points on the day. The steady rise and steeper angle of ascent of the up-volume line rela-tive to the down-volume line is an indication of solid buying power.
Figure 3 (bottom) shows the differ-ence between up volume and down volume compared to the S&P 500 on Nov. 1. When the opening bell rang, the S&P 500 was down from the pre-vious close and the diff e re n c e between up volume and down vol-ume was negative. At point A, the difference bottomed and climbed into positive territory just as the S&P 500 moved into positive territory.
Also, notice that while the volume d i ff e rence made a new high at point B, the S&Pdid not make a new high until a short time later. Not all stocks included in the calculation of the vol-ume statistics are in the S&P500. Here , up volume was continuing to climb at a faster pace than down volume, indi-cating the broad market was still ris-ing. The S&P 500 soon followed.
F i g u re 4 (p. 32) is more intere s t i n g . The top half of the chart shows the ratio (rather than the diff e rence) of up vol-ume to down volvol-ume. There appears to be a greater correlation between this calculation and the index, as the peaks and troughs of the two series are close-ly aligned. The ratio of up-to-down vol-ume runs nearly 2-to-1 for most of the day.
T h e re are two components to the ratio
— up volume and down volume. The next step is to analyze the individual compo-nents to see if an indicator can be cre a t e d .
Designing an indicator
The primary challenge of developing an indicator is to have up volume and down volume start each day at zero. To accomplish this, the indicator must be quick to drop values from the previous
day, like a simple moving average. Also, because both up volume and down vol-ume climb all day, it may be advanta-geous to calculate the rate of change of these values; acceleration or deceleration in the rate of change might forewarn, or
ACTIVE TRADER • May 2003 • www.activetradermag.com 44
continued on p. 45 Up volume - down volume
A
B
C S&P 500 (SPX), five-minute
1-8:30 9:30 10:00 10:30 11:00 11:30 12:00 12:30 13:00 13:30 14:00 1-14:30 Nov. As the S&P gradually moved up, so did the difference between up volume and down volume.
S&P 500 (SPX), five-minute
1-8:30 9:30 10:00 10:30 11:00 11:30 12:00 12:30 13:00 13:30 14:00 1-14:30 1-8:30 10:30 12:30 1-14:30
On an bullish day for the S&P 500 index, up volume (left) increased at a much greater rate than down volume (right).
FIGURE 2 UP VOLUME LEADS DOWN VOLUME
Source: CQGNet
1-8:30 10:30 12:30 1-14:30
FIGURE 3 MOVIN’ ON UP
at least confirm, the current price trend.
The most common way to measure rate of change is to compare the current value to the value x prices ago — for example, five bars, 10 bars, etc.
However, this isn’t necessarily the best m e a s u rement, because it ignores the prices between the current and the old-est in the lookback period. A better cal-culation would incorporate all the price
action in the lookback period. One such measurement can be derived from linear regression.
A linear re g ression line is a “best-fit” straight line plotted through data points. If the data points are zig-zag-ging upwards, a best-fit line drawn t h rough the points would be rising or have a positive slope. If the data points are zig-zagging downward s , the best-fit line would have a negative slope. If the data points were zig-zag-ging sideways, the best-fit line would be horizontal — that is, its slope would be zero. (For more information on re g ression lines, see “The next-bar f o recast”.)
The top of Figure 5 (bottom) shows up volume, and below it is an indica-tor that tracks the slope of a best-fit linear re g ression line of the up volume using a five-period lookback. (The first five readings are ignored because they include the previous day’s val-ues.) The market began on a negative note, but up volume was climbing f rom the early part of the day, and the slope indicator started just above zero . A little after 9:30 a.m. CT, the slope indicator shot above +250, indicating a l a rge increase in buying.
At points A and B the slope line dropped near zero and below zero at point C. These low readings coincid-ed very closely with the S&P’s pull-backs within the day’s uptrend. More importantly, the slope line was above zero almost the entire day and consis-tently had readings at or above +250.
Figure 6 (opposite page, top) is like Figure 5 except it shows down vol-ume. At point A, the slope was just over +150, much higher than the up volume reading for the same period in Figure 5. With down volume dom-inating the early market, the S&P 500 was down in the first hour of trading.
The peak at A coincided with the bot-tom in the S&P, and when the market began to advance, the slope line dropped to nearly -100 (point B). This is where the up volume advanced above +250 in Figure 5.
This change represented a real shift toward up volume, and the fact the up-volume slope line had a higher intra-day peak than the down-volume slope line suggested an uptrend was in the wings. For most of the day, the down-volume slope line stayed between -100
45 www.activetradermag.com • May 2003 • ACTIVE TRADER Up volume/down volume ra t i o
S&P 500 (SPX), five-minute
1 - 8 : 3 09 : 0 0 9 : 3 0 1 0 : 0 0 1 0 : 3 0 1 1 : 0 0 1 1 : 3 0 1 2 : 0 0 1 2 : 3 0 1 3 : 0 0 1 3 : 3 0 1 4 : 0 0 1 - 1 4 : 3 0 Instead of subtracting down volume from up volume, the top part of this chart shows up volume divided by down volume. Like Figure 3, the line steadily climbs throughout the d a y. However, this calculation tracks the S&P more faithfully than the subtraction formula.
FIGURE 4 THE UP-VOLUME/DOWN-VOLUME RATIO
Source: CQGNet
Up volume
Up-volume slope
B C A
S&P 500 (SPX), five-minute
1 - 8 : 3 0 9 : 3 0 1 0 : 0 0 1 0 : 3 0 1 1 : 0 0 1 1 : 3 0 1 2 : 0 0 1 2 : 3 0 1 3 : 0 0 1 3 : 3 0 1 4 : 0 0 1 - 1 4 : 3 0 Below the up-volume line (top) is a line reflecting the slope of a five-day linear regression line at each bar. A linear regression (or “best-fit”) line incorporates all data points of a lookback period. The slope sunk to (or below) the zero line at the same time price made intraday pullbacks.
FIGURE 5 THE UP-VOLUME SLOPE LINE
Source: CQGNet
Ignore these readings
to +100, except for one excursion to +200 at point D. This coincided with the worst sell-off of the day.
Figure 7 (bottom) shows how the up volume, down volume battle plays out on a down day. The top part of the chart plots the up volume divided by the down volume. The trading day started with the up-vol-ume/down-volume ratio above 40 percent, a number that fell to 20 per-cent by the end of the session.
The top portion of Figure 8 (p. 47) contains the up volume, with its slope line. The market opened down but the slope line bounced back to just below +75 at point A. For the bet-ter part of the day the slope stayed at relatively low levels as the market worked its way down. This con-firmed the lack of buying. The only decent rally came at point B, when the slope moved back to +75.
F i g u re 9 (p. 34) shows the down volume with its slope line for the same d a y. The slope line quickly moved above +100 and hovered near this level for most of the day until surg i n g higher toward the end of the day.
Although these are only two exam-ples of trending days, in both situa-tions the slope line provided a good indication of the dominant market force. Strong uptrending days have up-volume/down-volume ratios of 2-to-1 (200) or higher. Downtrending days are accompanied by up-vol-ume/down-volume ratios of less than 1-to-2 (50). On non-tre n d i n g days, the ratio tends to be much clos-er to 1-to-1 (100).
Market context
What sets the stage for an uptrending or downtrending day? Most often, some news event will push people’s psyches in one direction or the other.
The catalyst can be expected news, such as economic releases, or unplanned, such as a group of ana-lysts simultaneously making com-ments early in the morning.
Therefore, a quick check of the morn-ing volume statistics can often give an indication of what kind of day to expect.
If the news was good and the up-vol-ume/down-volume ratio is 200 or high-er, expect a market that will wind its way upward.
On the other hand, if
up-volume/down-volume is 50 or less after the first hour of trading, the sellers will likely be in control all day, barring some other news that reverses the crowd’s mentality.
Sometimes the market action may be more technical in nature — for example, the result of profit-taking after an
extended run, or a breakout of support and resistance. On days such as these, check the slope indicator early in the day and see whether up or down volume is more dominant. If the up slope line hits +200 and down slope line only rises to +50, higher highs are likely. On the other
ACTIVE TRADER • May 2003 • www.activetradermag.com 46
continued on p. 47 Down volume
Down-volume slope
C D
B A
S&P 500 (SPX), five-minute
1 - 8 : 3 0 9 : 3 0 1 0 : 0 0 1 0 : 3 0 1 1 : 0 0 1 1 : 3 0 1 2 : 0 0 1 2 : 3 0 1 3 : 0 0 1 3 : 3 0 1 4 : 0 0 1 - 1 4 : 3 0 The slope indicator for down volume peaked at the same points the up-volume slope line made temporary bottoms in Figure 5.
FIGURE 6 THE DOWN-VOLUME SLOPE LINE
Ignore these readings
Up volume/down volume ra t i o
S&P 500 (SPX), five-minute
9 - 8 : 3 0 9 : 3 0 1 0 : 0 0 1 0 : 3 0 1 1 : 0 0 1 1 : 3 0 1 2 : 0 0 1 2 : 3 0 1 3 : 0 0 1 3 : 3 0 1 4 : 0 0 9 - 1 4 : 3 0 The up-volume/down-volume ratio (top) on a day the S&P declined essentially mimics the downtrend in the index.
FIGURE 7 ON A DOWN DAY
Source: CQGNet Source: CQGNet
hand, if slope for the down volume climbs to +150, and the up volume drops to –60, the bears are in control.
Taking another step
During obvious trend days, another cal-culation involving the volume slope
indicators can help decipher intraday price action: the difference between the up-volume slope line and the down-vol-ume slope line. An uptrending day pro-vides the first example.
The concept here is the short-term market trend peaks as the up-volume
level peaks, and the up-volume slope line peaks shortly after. At the same time, the down-volume will trough and begin to rise, and the down-vol-ume slope line will turn up. Watching the diff e rences between the two slopes can highlight volume changes, and in turn, market shifts.
F i g u re 10 (opposite page, top) is another chart of Nov. 1. The top part of the chart plots the diff e rence between the up-volume slope line and the down-volume slope line. (Remember the first five readings are ignored because they incorporate the pre v i o u s day’s readings.) A horizontal line is placed at +50, a level chosen (instead of z e ro) because the diff e rence between the two slopes may not cross zero .
Recall that just after 9:30 CT on this d a y, the up-volume level cro s s e d above the down volume level (see Figure 3), and the up-volume/down-volume ratio was close to 2-to-1 (see F i g u re 4). Both developments are signs of an emerging uptrend.
Let’s develop some hypothetical trading rules:
1. A buy signal occurs when the slope-difference line turns up after it has fallen below 50.
2. The risk point is just below the low of the entry bar.
3. Take a profit when the slope-dif-ference line crosses above 50, and then back below 50.
Each letter in Figure 10 marks an entry; the exits are marked on the a p p ropriate price bar. There are a number of good entry and exit points, with some losing trades occurring during congestion (see points C and D). Trade E was stopped out because the market traded below the low of the entry bar. However, because the s l o p e - d i ff e rence line was below the +50 line, the trade was re - e n t e re d . Another idea is to experiment with a higher exit threshold, such as a rise above and a drop below 200.
F i g u re 11 (opposite page, bottom) shows a downtrending day. In this instance, we placed a horizontal line at the -50 level of the chart showing the diff e r-ence between the two slopes. For a down-trending market (i.e., the difference between the up volume and down volume is negative, and the up-volume/down-volume ratio is 50 percent or less), go short
47 www.activetradermag.com • May 2003 • ACTIVE TRADER Up volume
Up-volume slope
A
B A B
S&P 500 (SPX), five-minute
9 - 8 : 3 0 9 : 3 0 1 0 : 0 0 1 0 : 3 0 1 1 : 0 0 1 1 : 3 0 1 2 : 0 0 1 2 : 3 0 1 3 : 0 0 1 3 : 3 0 1 4 : 0 0 9 - 1 4 : 3 0 Short-lived intraday rallies are accompanied by peaks in the up-volume slope line.
FIGURE 8 UP-VOLUME SLOPE ON A DOWN DAY
Source: CQGNet
Down volume
Down-volume slope
S&P 500 (SPX), five-minute
9 - 8 : 3 0 9 : 3 0 1 0 : 0 0 1 0 : 3 0 1 1 : 0 0 1 1 : 3 0 1 2 : 0 0 1 2 : 3 0 1 3 : 0 0 1 3 : 3 0 1 4 : 0 0 9 - 1 4 : 3 0 The slope of down volume remained steadily above the zero line and shot up at the end of the day when the index declined.
FIGURE 9 DOWN-VOLUME SLOPE ON A DOWN DAY
Source: CQGNet
when the slope-diff e rence line is above -50 and turns down. The risk point is just above the high of the entry bar, so take profits if the slope-diff e rence line c rosses back above -50.
The first trade (point A) was a loser, but the next trade was pro f i t a b l e despite a lower entry point than the p revious trade. Trade C was caught in some sideways market movement.
You would not re-enter after this trade because the slope-diff e rence line was below -50, not above. Trade D had a nice open profit, but the majority was given back, and trade E was a good run down until the close.
These signals could be improved by calculating the typical price move fol-lowing an entry, using maximum favorable excursion (MFE) analysis to set targ e t s .
The ups and downs of the market
Intraday up- and down-volume sta-tistics offer insight into the dynamics of buying and selling pressure. When the up- and down-volume numbers are nearly the same throughout the day, the market tends to trade back and forth — the case on most trading days. However, there are days when the market makes significant moves, and the intraday volume numbers can help identify trade opportunities.
R e m e m b e r, there is usually some event that causes people to favor one side of the market on a given day. In the first hour or two, you can deter-mine if up or down volume is domi-nating by looking at the raw diff e re n c e between the two, the ratio or by using slope analysis. However, tre n d i n g conditions do not develop every day, which is why intraday traders have mostly good days and bad days and, only occasionally, great days.
The concept of tracking the intra-day volume statistics presented here is the groundwork for further research. Traders could use the slope-difference line of the up volume and down volume as the basis for a sys-tem, or elements for either entry and exit strategies within other systems.
Finally, on those days with a bullish bias, watch for the down volume indica-tor to show signs that its ascent is wan-ing. The market will typically rally from that point. Likewise, on bearish days, the
bears will take charge when the up vol-ume slows. This may seem counter-intu-itive, but it will have you thinking about buying in an uptrend (after a pullback driven by an advance in the number of
down-volume stocks) or selling a rally (after a short-term rise in the number of up-volume stocks).
Ý
ACTIVE TRADER • May 2003 • www.activetradermag.com 48
Slope difference
S&P 500 (SPX), five-minute
1 - 8 : 3 0 9 : 3 0 1 0 : 0 0 1 0 : 3 0 1 1 : 0 0 1 1 : 3 0 1 2 : 0 0 1 2 : 3 0 1 3 : 0 0 1 3 : 3 0 1 4 : 0 0 1 - 1 4 : 3 0 The difference between the slope of the up-volume line and the slope of the
down-volume line captures many of the market’s intraday turns. Trades that were entered are marked by letters, with the exits noted.
FIGURE 10 SLOPE-DIFFERENCE LINE
Source: CQGNet
S&P 500 (SPX), five-minute
9 - 8 : 3 0 9 : 0 0 9 : 3 0 1 0 : 0 0 1 0 : 3 0 1 1 : 0 0 1 1 : 3 0 1 2 : 0 0 1 2 : 3 0 1 3 : 0 0 1 3 : 3 0 1 4 : 0 0 9 - 1 4 : 3 0 When the trend is down, the slope differential can be used to signal trade
opportunities. Moves above and below the -50 line are the initial triggers.
FIGURE 11 TRADING ON A DOWN DAY
V
olatility, although often as-sociated negatively with choppy, uncertain market conditions, is essential for traders: The market has to go somewhere to make a position profitable. What traders wish for is not low-volatility con-ditions; on the contrary, they prefer high volatility occurring in the direction of their positions.The degree of volatility is especially crucial for intraday traders because they try to capture short-term price move-ment; they do not have the luxury or desire to hold a position overnight. For such traders, knowing when the most volatile periods occur during the trad-ing day would be a valuable piece of information — if there were a consistent pattern to that volatility. Traders could then focus on those periods with the most promise of price movement and avoid those less likely to offer tradable volatility.
Gathering the evidence
We will determine if different times of
49 www.activetradermag.com • August 2003 • ACTIVE TRADER