Trading Basics--Price and Volume Trend

09/27/2008 12:00 am EST

Focus: STRATEGIES

Thomas Aspray

, Professional Trader & Analyst

In recent articles, I covered some popular volume indicators such as the Accumulation Distribution and the Money Flow Index that were developed in part to improve on the On Balance Volume (OBV), developed by Joseph Granville and one of my favorite technical studies.

Another such indicator is the Price and Volume Trend (PVT). While the OBV would add or subtract the entire volume for the period depending on whether the close was higher or lower than the previous period, the PVT adds or subtracts only a portion of the volume, depending on where the close was in relation to the previous close. If the close was just slightly higher than the previous close, then just a small fraction of the volume is added in; if the close was much higher, then a large portion of the volume would be added in. The formula is as follows:

Formula 1

This is then added to the summation of the previous periods’ PVT. The interpretation of the PVT is similar to that of the OBV, in that you look for positive or negative divergences between the PVT and price, as well as instances where the PVT is acting stronger or weaker than prices. I have also found it useful to run a 21-period weighted moving average (WMA) over the PVT.

Figure 1

The first chart I would like to look at is Apple Computer (AAPL), which has been a market leader over the past few years. In this chart, I have also included a standard volume plot just to reinforce the importance of looking at the volume within any market you are following, especially if it has just had a large up- or down-day. Often times, just the volume bars will tell you something important about the price action. In the middle of July 2005, AAPL closed above its short-term weekly downtrend (line a) as indicated by point 1. This price action was confirmed when the PVT closed above its WMA (green line) at point 2. On the lower part of the chart, you will note that volume had been declining for the past nine weeks, but increased sharply as prices closed above their downtrend (point 3). This was a strong indication that the price action was signaling a change in trend. AAPL peaked early the next year above $85 per share and the PVT confirmed the price action as it also made a new high. AAPL began to correct and formed a classic continuation pattern over the next nine months as indicated by lines b and c. The first indication that the correction was over, came the week of July 22, 2006, when AAPL closed up sharply on 224 million shares well above the prior week’s volume of 161 million shares. The PVT, despite the lower lows in price (line c) formed a positive divergence (line e). The surge above the WMA and the completion of the continuation pattern on the PVT led the completion of the price pattern by one week as noted by the vertical line 4. The pattern of lower highs on the volume plot was also broken. The completion of the continuation pattern on the weekly chart, lines b and c, had upside targets in the $85 area.

Figure 2

The price action of AAPL is continued in Figure 2 as it moved above $93 per share in December and then approached the $98-level in January before it started to correct. The PVT stayed above its WMA as prices consolidated and did not drop below it until August 2007. From the January highs to the late April lows, AAPL formed another continuation pattern (lines A and B). The PVT confirmed the weekly close above resistance at line A on April 28, 2007, as it surpassed its previous high (line C). The ensuing rally has taken AAPL from $100 per share up to the $150 area. The PVT dropped below its WMA during the sharp decline that began in July 2007; however, it quickly reversed and has now moved above its WMA and the trend line resistance (point 1). Over the past three years, the PVT has yet to form any significant negative divergences.

Figure 3

Over the past four years, the basic materials sector has been one of the strongest sectors, outperforming the S&P 500 by over 45%. One of the strongest stocks in this sector has been Freeport-McMoRan Copper & Gold (FCX), as it has benefited from both the rise in copper and in gold prices. The weekly chart illustrates some similar signals as those we observed in Apple. In 2002 and early 2003, FCX had significant resistance (line a) in the $19-$21 area. On May 17, 2003, FCX closed above this weekly resistance; during the next week, the corresponding resistance in the PVT (line b) was also overcome as indicated by vertical line 1. The PVT had moved above its WMA several weeks earlier and stayed above it until January 17, 2004, when prices reversed after exceeding the $46 level. FCX corrected sharply and then moved sideways for a few weeks before again challenging the previous highs. On this rally, the PVT just rebounded back to its flat WMA (point 2) and then turned down as the rally stalled. I have frequently observed similar formations, which have provided quite reliable trading signals where the risk can be well controlled.

The next decline was especially sharp as FCX declined over 25% in the next ten weeks. This began what turned out to be a 20-month period of consolidation as indicated by lines c and d on the weekly chart. A similar formation was evident on the PVT, but on June 18, 2005, the PVT moved above its WMA and then on July 23rd, the PVT resistance was overcome (line 3). In this case, the PVT broke through resistance seven weeks before the corresponding price level on the weekly chart (line c). The continuation pattern on the weekly chart had an upside target in the $65 area that was reached in early 2006.

Figure 4

The weekly chart of FCX is continued in Figure 4 and shows that it made another new high in April 2006 that was confirmed by the PVT (red circle). FCX then consolidated once more as another continuation pattern (lines a and b) was formed over the next year. On March 17, 2007, FCX had a weekly close above resistance (line a) confirmed by the PVT as it overcame its resistance (line c) as indicated by vertical line 1. Once again, FCX accelerated to the upside as the 100-level was reached in July before a sharp 30% correction. It is important to note that the PVT did confirm the July highs (red circle) suggesting that an important top was not yet in place. FCX has again closed at new all-time highs with the PVT confirming these new highs.

Figure 5

Of course, no indicator works all of the time or on every market, and while I have found both the OBV and PVT to be quite reliable tools the majority of the time, there are indeed exceptions. To illustrate this, the chart for Countrywide Financial (CFC) is shown above. Countrywide Financial was one of the main casualties of the sub prime crisis during the summer of 2007. The PVT surged above its WMA on October 28, 2006 (point 1) and the PVT did confirm the early February highs at $45. The reversal from the highs was quite sharp as the PVT dropped back below its WMA in March (point 2) as CFC again tested the important support in the $32-$33 area. By April 21st, the PVT once again moved back above its WMA (point 3) and even though the rally failed in the $41-$42 area, the PVT made higher highs (line a). This was later shown to be a very misleading signal. CFC again started to drift lower and then dropped back below its WMA the week before the sub prime crisis hit the market (line b) and key support was violated. Though this signal looks a bit late CFC did drop another 50% during the next four weeks.

As you probably noted that I have featured only weekly charts in this article, but PVT, like the OBV, can be used on weekly and daily or even monthly data. To summarize, I would start first with the weekly data and run the PVT on any markets or issues where you are looking to establish a position. Use an overlay of the 21 WMA on the PVT as it may allow you to better identify a trend. Then look to see if there are any divergences, either positive or negative. As these examples illustrated, if the market is a continuation pattern, then look for a breakout in the PVT to lead the breakout in price. This should allow you to use a fairly tight stop loss and to easily determine a profit target. The PVT has many similarities to the OBV, but as for which one is “best,” I couldn’t give you a statistically sound answer. Many of the nuances that I have observed over the years in the OBV are not easily tested. The PVT might be a volume indicator that you can use with more confidence, and if so, that would be great, while others may find the OBV or Demand Index more useful. The bottom line, however, is to not leave volume out of your analysis.

Tom Aspray began doing computer analysis of the financial markets in the early 1980s. He helped to introduce many of the technical tools that are now very popular though his writings and lectures around the world. He now works as a private consultant and educator. He would welcome your comments and suggestions at tomaspray@intershow.com.

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