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Trading Volume Spikes

(part 2)

Using Volume Moving Averages (VMA) and the Percentage Volume Oscillator (PVO)

Above, we discussed how the magnitude and duration of a volume spike can impact the extent of a future trend reversal. In order to be able to gauge these parameters objectively, it is imperative that we apply appropriate mathematical tools to the study of volume spikes.

The Percentage Volume Oscillator (PVO) fits this purpose. It represents the relationship between two volume moving averages. The formula to calculate PVO is simple

PVO = ([Fast VMA] - [Slow VMA]) / [Slow VMA], where

  • VMA = a volume moving average;

  • The �fast VMA� represents a short-term VMA;

  • and the �slow VMA� is a longer-term VMA.

Compared to the short-term (i.e., the �fast�) VMA, the long term (i.e., the �slow�) VMA represents an average of the volume readings over a comparatively longer period of time.

For instance, assume you saw a large volume spike develop on an index over the past two days. Let us say, you calculate the PVO at this point, using a 2-day VMA as the fast VMA and a 25-day VMA as the slow VMA. A PVO calculation would then give you the magnitude of the VMA spike that had duration of two days.

Returning to the example presented above, if you calculated the PVO for the two-day volume surge you noted, but decided to use a 5-day VMA rather than the 2-day VMA as the fast VMA (keeping the 25-day VMA as the slow VMA), results would differ greatly. Since the high-volume activity in our example occurred only over a two-day span, the 5-day VMA would show lower values than the 2-day VMA because the former would consist of an average of 3 �low-volume days and two high-volume days.

By maintaining the slow VMA at a steady level and altering the period of the fast VMA, one can define the minimum duration of a VMA spike under analysis.

While the fast VMA defines the duration of a VMA spike, the PVO value is used to characterize the magnitude of a volume spike. The greater the PVO value, the larger a spike's magnitude, and by extension, the bigger the potential impact on the market trend.

Chart 1: Example of an intraday application of the PVO.
S&P 500 index. April 22, 2005.
Fast VMA = 15 minute volume moving average; slow VMA = 1-day volume moving average.

The main advantage of the PVO indicator lies in its absolute value. When analyzing historical market data, various PVO values can be compared objectively - critical PVO levels for a specific index can thus be determined in an (emotionally) unbiased way.

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