Defining the Trend

By Walid Khalil, CFTe, MFTA

When I developed the Volume Zone Oscillator (VZO) back in 2009, the main idea was to translate Dow’s basic tenets” Volume Goes with the Trend” to an oscillator.

This article will introduce the Volume Zone Oscillator (VZO) with its trading tactics to reach the trend definition from the volume point of view applying all the interpretations to the S&P500 from 2008 till 16 July 2011.

Volume Zone Oscillator

Volume’s leading characteristics is the basic premise of this oscillator; in fact, it is a leading volume oscillator, unlike other common volume indicators which primarily depend on the concept of divergence, which in itself is not a signal; the trader has to wait for a price confirmation before executing a trade.

Waves of buying and selling are basically originated as a result of continuous battle between bulls and bears, which is the idea behind separating bulls from bears, to identify the direction of the next move depending on volume analysis.

This oscillator basic usefulness is in giving leading buy/sell signal, also identifying overbought/oversold volume conditions.

The formula of the VZO which separates bulls’ volume from bears’, aided in providing the buy/sell signals. Moreover, VZO is primarily used to identify at which zone volume is positioned, to decide which side we should ride on.

The Calculation

The formula depends on only one condition, if the close of today is higher than the close of yesterday, the volume will have a positive value (Bullish), otherwise it will have a negative value (Bearish).

Volume zone oscillator = 100 X (VP÷TV).

Where, VP (Volume Position) = X-days EMA (± volume).

And, TV (Total Volume) = X-days EMA (volume).

From the formula above, Bulls’ volume moves the oscillator up, while bears’ volume moves it down.

The default period is 14; however, the period can be adjusted for sensitivity or for preferred time frame.

Equis Metastock® Indicator Builder Formula

Period := Input(“Y” ,2 ,200 ,14 );

R :=If(C>Ref(C,-1),V,-V);

VP :=Mov(R,Period ,E);

TV :=Mov(V,Period ,E);

VZO :=100*(VP/TV);

VZO Trading Tactics

Trading Tactic 1

Uptrend Volume Psychology

During up trends, volume rises with rising prices and falls during corrections; that is one of Dow basic tenets” Volume Goes with the Trend”. ‎(1)

Long term investors tend to accumulate shares gradually, leading to a major shift in the (demand / supply) outcome towards the demand, which in turn leads to waves of higher lows followed by higher highs. Volumes tend to increase on new price territories and decrease during downward corrections. ‎(2)

VZO Interpretation

Retracing from positive 40 and failure to reach the lower boundary indicates that not all the shares which have been bought below are sold; also means, bulls have entered early due to the lack of supply. Thus, crossing the zero line from below generates a buy signal.

Template demonstrates ideal buy/sell signal during uptrend.

From the template chart above, during bulls’ periods and due to their strength, VZO tends to rebound before reaching the lower boundary.

This is the ideal case in uptrend; VZO will not reach the lower boundary and will rebound from a zone above -40.

Egyptian Exchange Index (EGX30.CA) – Daily Chart

Egyptian Exchange Index (EGX30.CA) – Daily Chart

The chart above demonstrates an ideal VZO movement during an uptrend, in which, the VZO has a tendency to stay in the upper zone fluctuating between zero and 40.

Re-Entry

When VZO crosses down +40 giving a sell signal, but it does not retrace further than the zero line, then VZO bounces back up towards the upper boundary, this is considered as a sign of strength, and a re-entry signal when VZO re-crosses +40 from below.

To avoid whipsaws, filters can be used. That’s to say, buying on the break of 45 or 50 instead of 40. By using filters, we ensure that the move is powerful enough, and increase profitability odds.

Upper Egypt Flour Mills (UEFM.CA) - Daily chart - Egyptian Exchange

Upper Egypt Flour Mills (UEFM.CA) – Daily chart – Egyptian Exchange

Trading Tactic 2

Downtrend Volume Psychology

During ideal downtrend, volume rises with falling prices and falls during upward corrections.‎(1)

Long term investors tend to lay off their shares gradually, leading to a major shift in the (demand / supply) outcome towards the supply, which in turn leads to waves of lower highs followed by lower lows.‎(2)

VZO Interpretation

Rebounding from negative 40 and failure to reach the upper boundary indicates that not all shares which have been sold above are bought, also means that bears have entered early due to the lack of demand, thus, crossing the zero line from above generates a sell signal.

Figure ‎0 1 Template demonstrates ideal buy/sell signal during downtrend.

From the template chart above, during bears’ periods and due to their strength, VZO tends to retrace before reaching the upper boundary indicating weakness.

EFG-Hermes (HRHO.CA) - Daily Chart - Egyptian Exchange

EFG-Hermes (HRHO.CA) – Daily Chart – Egyptian Exchange

The chart above demonstrates an ideal VZO movement in a downtrend, in which the VZO has a tendency to stay in the lower zone fluctuating between -40 and zero.

Exit Signal:

When VZO crosses up -40 giving a buy signal, and then retrace toward the lower boundary before touching the zero line, it is considered a sign of weakness, and the trade should be exited once VZO crosses below -40.

To reduce whipsaws, it is recommended to use filters in downtrend by crossing down -50, and in an uptrend by crossing down -45.

Bed Bath & Beyond Inc (BBBY) - Daily Chart - NASDAQ Exchange

Bed Bath & Beyond Inc (BBBY) – Daily Chart – NASDAQ Exchange

Trading Tactic 3

Sideway Trend Volume Psychology

During sideway trends, the demand / supply outcome is neutral; just waves of buying followed by waves of selling forming main support and resistance.‎(2)

VZO Interpretation

When VZO reaches the zone between -40 and -60, it means that bears have already offloaded their shares, which increases the likelihood of the bulls to step in; vice versa, with the zone between +40 and +60.

Crossing -40 from below generates a buy signal, while crossing +40 from above generates a sell signal.

Volume Zone Oscillator

Template demonstrates simple buy/sell signal.

From the template chart above, a buy signal is triggered when the VZO crosses negative 40 from below; while a sell signal is triggered when the VZO crosses + 40 from above.

This tactic is more suitable for sideways trend; during those periods the VZO tends to fluctuate between -40 and 40.

Below are some examples from different markets that apply this tactic.

Dow Jones Industrial Average (DJI) - Daily Chart

Dow Jones Industrial Average (DJI) – Daily Chart

Alvarion Ltd. (ALVR) - Daily chart – NASDAQ Exchange

Alvarion Ltd. (ALVR) – Daily chart – NASDAQ Exchange

Egyptian Telecom (ETEL.CA) - Daily chart - Egyptian Exchange

Egyptian Telecom (ETEL.CA) – Daily chart – Egyptian Exchange

Defining the Trend

Now after introducing the trading tactics let’s see behind the signals.

What is the trend of the below VZO image?

Volume Zone Oscillator

Yes, it is down trend and you can see the distribution is clear. Now let’s see the full image.

S&P500 – Weekly Chart

Now, the second question, do you see strength at the end of the chart?

Yes the VZO reached a level that it did not reach for more than a year. Now let’s move forward.

What is the trend of the below VZO image?

Yes, it is an uptrend and you can see the accumulation clearly. Now let’s see the full image.

S&P500 – Weekly Chart

Now, the new question, do you see any change at the end of the chart?

Yes the VZO reached is indicating a change in trend to a sideway attitude, it can’t reach either the oversold or the overbought; hence, there is no money coming into or getting out of the market. Now let’s move forward.

What do you understand from the below image?

The uptrend resumed after a small break. Now, do you see and weakness at the end of the chart?

Yes, a series of lower highs followed by reaching oversold level for the first time in a year indicating a distribution. Let’s see the full chart

S&P500 – Weekly Chart

Now we can add a negative divergence to our analysis confirming the weakness.

Now the big question, what do you expect next?

I expect a rebound followed by retracing from the zero line, why?

First, an extreme level over 60 followed by a clear negative divergence and finally reaching oversold for the first time in 15 months. Definitely there is something changing.

Finally let’s see the picture as this week.

S&P500 – Weekly Chart

Bingo, the VZO showed all trend changes in the S&P500 for the last 3 years and we can see clearly how money is moving in and out of the market.

Now, after the apparent weakness a new buy signal will only be triggered after crossing the 20 level as a filter for crossing the zero line.

Conclusion

Volume analysis is an area which invites greater investigation. This article has utilized the separation of bullish and bearish volume to construct an oscillator that leads price moves. VZO is a complete system based on volume analysis, which produces effective buy and sell signals during different kinds of trends; VZO can also highlight hidden strength and weakness in the market.

Biographies

Walid Khalil, CFTe, MFTA, is a member of the International Federation of Technical Analysts (IFTA) and chief technical strategist at HA Brokerage, Cairo, Egypt. He is the head of the publication committee and a technical analysis instructor at the Egyptian Society of Technical Analysts (ESTA). He may be reached at waleedkhalil@live.com.

References

(1) Edwards, Robert D. and Magee, John: Technical Analysis of Stock Trends, 8th Edition, (New York: St. Lucie Press, 2000), P. 15-21

(2) Kirkpatrick, Charles D.: Technical Analysis – The Complete Resource for Financial Market, (New Jersey: FT Press, 2007), P. 14, 15, 17, 416

Trading involves substantial risk of loss and is not suitable for all individuals. Past Performance is not indicative of future results.