In this article we look at the volume rate of change (V-ROC), and we'll focus on the importance of price movements and volume in the study of market trends.
In the last decade, we've seen triple-digit swings on the Dow Jones Industrial Index to both the upside and the downside. A newcomer to the science of technical analysis may not have realized that some of these moves lacked conviction, as volume didn't always support the price movement. Chartists are not the least bit interested in a 5 to 10% move in a stock price if the volume moving the price is a fraction of the normal daily volume for that particular issue.
On the other hand, since the Nasdaq market volume reaches or surpasses two billion shares per day, significant price action will trigger the interest of analysts. If price movements are significantly less than 5 to 10%, you might as well go golfing.
Volume Trend Indicator
The volume rate of change is the indicator that shows whether or not a volume trend is developing in either an up or down direction. You may be familiar with price rate of change (discussed here), which shows an investor the rate of change measured by the issue's closing price.
To calculate this, you need to divide the volume change over the last n-periods (days, weeks or months) by the volume n-periods ago. The answer is a percentage change of the volume over the last n-periods. Now, what does this mean? If the volume today is higher than n-days (or weeks or months) ago, the rate of change will be a plus number. If volume is lower, the ROC will be minus number. This allows us to look at the speed at which the volume is changing.
One of the problems that analysts have with the V-ROC is determining the period of time to measure the rate of change. A shorter period of 10 to 15 days, for example, would show us the peaks created by a sudden change, and, for the most part, trendlines could be drawn.
For a more realistic look, I would suggest using a 25- to 30-day period; this length of time makes the chart look more rounded and smooth. Shorter periods tend to produce a chart that is more jagged and difficult to analyze.
In fact, if you study the chart closely, you can see that the ROC becomes positive for the first time on Dec 12, 2001, with a measurement of 19.61. On the next day the measurement jumps to 249.00 on the closing. The Nasdaq, however, had a high of 2065.69 on December 6 (ROC, +8.52) and then fell to negative numbers until December 12. By using a 14-day period, we cannot recognize this slide until the Index loses 119.18 points (approx. 6.5%) to the level of 1946.51. This would confuse most, were it not for the ability to change our period of time, in this case, to a 30-day period, shown below.
In the second chart of the Nasdaq Composite Index, which uses a 30-day period, you can clearly see that in and around December 12 and 13, 2001, the ROC barely shows a positive number, and it is not until January 3, 2002 that a positive number appears, as the price action rises substantially from 1987.06 to 2098.88. On the ninth of the month, there is a move to the upside of 111.82 points. This positive value means there is enough market support to continue to drive price activity in the direction of the current trend. A negative value suggests there is a lack of support, and prices may begin to become stagnant or reverse.
We can see that even with a 14-day period, the V-ROC over the year shown on this chart, for the most part, moves quietly above and below the zero line. This indicates that there is no real conviction for there to be a trending market. The only real jump in price action that most investors missed is the move in late July, occurring over a period of five trading days, which, as you can see in the chart, has given almost everything back.
Another interesting point is the lack of volume behind the price action as it moves upward. This is evident in the period from August 5, 2002, when the Nasdaq closed at 1206.01, to Aug 22, 2002, when the index closed at 1422.95. During this time, the V-ROC remained negative, indicating to all technical analysts that the increasing price in the index would not hold.
The Bottom Line
Using the previous volume indicators, you can confirm price movements that have conviction and avoid buying or selling based on blips in the market that will soon be corrected. Watch the volume, and the trends will follow. Remember it's your money - invest it wisely.