Wednesday, October 17, 2018

The Power Measure: How Is Volume Moving Price?

In the most recent Forbes article, I highlighted the importance of monitoring the amount of movement we get per unit of market volume.  When we look at normal bar charts, we see price as a function of time, with volume on the X-axis.  A large bar tends to be one in which we see increased volume (increased participation at that point in time), moving the market more than usual.

A different way of viewing market behavior is to look at volume bars (price where each bar represents an amount of volume traded) and see if bar size (volatility) is expanding on the upside or downside.  What this is telling us is not just how much volume is coming into the market, but how much each unit of volume is actually moving price.  When we see bigger bars coming in on market upmoves than downmoves, we can actually visualize where the market is finding its greatest ease of movement.

(This is a great example of the importance of creativity in trading.  Looking at price-volume-time through different lenses enables us to see fresh relationships that can illuminate what is actually going on in the market.  Looking at the same charts as everyone else is a great way of seeing the same things as everyone and becoming part of the proverbial herd.)

Above we see the full day's trade in the ES futures for 10/16/2018.  It's a great day to study, given the major turnaround in the overnight session and trend day during NY hours.  The blue line is the ES futures, with each bar representing a small unit of trading volume.  The red line is a running correlation of the size of the bars and the directional movement (open to close) of the bars.  Hence, when we get more upside movement per unit of trading volume, the correlation goes positive and vice versa.  

Shifts in this "power measure" tell us that volume is moving price more easily in one direction than another--a worthwhile heads up, though not a precise timing measure.  Notice, for example, how the correlation shifted positive and stayed positive during the period of the market's big turnaround.  Notice how subsequent moves lower in the correlation occurred at successively higher price lows--a great indication of the underlying strength of the market.

This is a relationship relevant to multiple time frames.  The illustration above, with over 500 bars per day, is clearly relevant to active day traders.  I maintain the measure for bars with much larger volume to examine multiday patterns.  The value of such measures is not as crystal balls, but as multiple lenses through which we can understand the dynamics between buyers and sellers.  There are many other such lenses, such as the shifts in distribution of upticks and downticks across all listed stocks.  Many trading problems occur, not because of emotional disruption, but because of cognitive poverty:  an absence of perspectives that yield fresh, valid insights.

Further Reading: