Saturday, April 28, 2007

Overview of the Relative Dollar Volume Flow Indicator

Before I post a sector-by-sector analysis of relative dollar volume flows into the various segments of the S&P 500 Index, I want to head off questions by reviewing the logic behind the relative dollar volume flow indicator. For background, here is my initial post on the topic; here is a nice illustration of the pattern of flows that preceded the big market drop in late February/early March; and here is a post that illustrates flow patterns at market bottoms. An illustration of flow in the S&P stocks also illustrates trading patterns.

Here is how I compute relative dollar volume flow for a particular stock:

1) The indicator begins with a calculation of money flow (net dollar volume). Money flow is calculated by multiplying the price of the stock times the volume traded for each trade during the day. If the price occurred on an uptick, the dollar volume is added to a cumulative total. If the price occurred on a downtick, the dollar volume is subtracted from the total. At the end of the day, you have the net dollar volume for that day.

2) I then adjust money flow for the volume traded that day. Because actively traded stocks would be expected to generate larger net dollar volume flows than less active, smaller ones, I create a more apples-to-apples comparison by dividing the money flow (net dollar volume) by the total share volume traded on that day. Hence the term relative dollar volume flow. If a large portion of a stock's daily volume occurs on upticks, for example, relative dollar volume will be very high--even for a low volume stock.

3) Then I see how recent relative flows compare to past flows. My research suggests that it is the acceleration and deceleration of relative dollar volume flows that are important to track for determining short/intermediate-term market strength or weakness. As a result, I subtract from each day's relative dollar volume flow the average relative dollar volume flow for the prior 200 trading sessions. This tells us whether we have above- or below-average levels of flow, with zero representing a level of flow equivalent to that of the past 200 days.

4) I track a short-term moving average of adjusted relative flows. My charts display a 10-day average of this adjusted relative dollar volume flow for purposes of smoothing. We're thus seeing how relative flows over the past 10 days compare with those over the prior 200 days.

I have received many requests from traders to help them set this up themselves, adapt the indicators in various ways, etc. Unfortunately, my time demands don't permit me to fulfill these requests. What I can tell you is that I receive raw money flow data from Townsend Analytics' RealTick platform, transfer the data to Excel, and conduct all calculations and assemble all charts in Excel.

For those sane individuals not inclined to gather all this information themselves, I report the adjusted relative dollar volume for the 30 Dow stocks every day in the Trading Psychology Weblog. I also periodically summarize the flows into and out of the S&P sectors on this site.

Finally, on a personal note that I will be expanding upon in this weekend's entry into my Trader Performance page, I am finding the patterns in the strength (new high/low); momentum (Demand/Supply); sentiment (Adjusted TICK); and relative dollar volume flow indicators to be so strong that I am making major changes in my own trading. I hope to share the results of these changes in future posts. I will also be taking a future look at intraday readings of flows--a much more ambitious research undertaking.

2 comments:

John L. said...

Hi Dr. Brett,

Thanks for the clarification. I’m one of the insane individuals and I have started toying with developing an indicator for your Relative Dollar Flow.

I’m curious if your calculation changes for an intraday RDF calculation. Since the Net Dollar Volume is calculated for the entire day and then adjusted as you describe.

Do you drop the “Apples to Apples” adjustments and just not compare on an intraday basis, do you perform the adjustments at a set time interval (every X minutes), or am I missing the boat and off base from an intraday perspective?

Thanks,
John

Brett Steenbarger, Ph.D. said...

Hi John,

For my first effort, I'll be calculating relative dollar volume flows for each 15 minute period across the 30 Dow stocks and then seeing how that correlates with price movements in DIA.

Brett