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Major Technical Analysis Components that Gauge Strength of a Prevailing Trend, Predict Trend Reversals and Help Time Entries and Exits for Index Credit Spread & Iron Condor Options

There are four major components of technical analysis that help investors make stock and option trading decisions:

Price Based indicators

Volume Based Indicators

Advance/Decline Based Indicators

Volatility Based Indicators

 

Two of these components, volume and advance/decline based indicators, offer the best capabilities to gauge strength and duration of a prevailing trend, and to predict the timing of an upcoming trend reversal, which ultimately help us better time our credit spread and iron condor entries and exits. 


This article primarily reviews the Volume based indicators and demonstrates that changes in volume will many times precede changes in price of a stock or index.  In other words, changes in volume is an early and somewhat hidden predictor of a stock or index's future price.

Below is a 60 day volume-based chart on the S&P 500 index - SPX, showing the primary indicator the SBV Oscillator.  The components of the chart are as follows:

SPX Price - Price of the SPX is shown as candlesticks

60 Day Chart - The 60 day chart provides insight into future price moves of the SPX over a 1 to 2 week period.

60 Minute Bars - Every 60 minutes of trade the total volume of shares that are traded within the SPX index are tallied.  (i.e. combined volume of all 500 stocks that reside in the SPX index)  A green bar represents "up volume" where buying outstripped selling and the index rose during the 60 minute increment; and a red bar represents "down-volume" where the selling outstripped buying and the index dropped during the 60 minute increment.

Volume Moving Average (VMA) -  The 12 day (simple) VMA, shown as the thin blue line, provides insight into volume surges and is used as input to calculate many of the additional indicators that we'll be covering below.

SBV Oscillator - Selling/Buying Volume Oscillator is a primary proprietary indicator that shows bullish volume accumulation and bearish volume accumulation.  That is, it calculates the difference between volume that is generated as the index advances (buying volume) and volume that is generated as the index pulls back (selling volume).  SBV Oscillator is the main indicator that provides the "go long" and "go short" triggers.  When the SBV Oscillator crosses above the -33% red trigger line it signals "go long", and when it drops below the +33% red trigger line it signals "go short".

Further analyzing the above volume-based chart, we can see that the SBV Oscillator gave an early and false "go long" signal around October 30th.  The recommended approach to reduce false signals is to also look at the longer-term chart(s) to confirm the trend reversal.

Below is a longer term 1 year chart with 1 day bars.  We can see from this bigger-picture perspective that the trend reversal was not confirmed until the 2nd week of November.  In order to minimize false "go long" or "go short" triggers, one would do the following:

1) The "go long" is triggered on Oct 30th from the 60 day chart, when the SBV oscillator crossed above the -33% red trigger line.

2) Zoom out to the 1 year chart to see what this chart is saying; in this case between October 1st and the first week of November the SBV Oscillator tells us to "stay out" or "continue to be short".  Because the 1 year chart is telling us to "continue to be short" we decide to not to open a trade.

3) Back to the 60 day chart, we get another "go long" trigger around Nov 3rd. 

4) Looking at the 1 year chart, once the SBV Oscillator starts to climb where it's just ready to turn green, which is near the end of the 2nd week of November, this validates a trend reversal and we then "go long".

Helping us further minimize false "go long" and "go short" trend reversal signals generated by the SBV Oscillator, as well has having insight into the prevailing trend, we add additional and complementary price, volume/price hybrid, and advanced/decline based indicators. 

SBV Oscillator - Selling/Buying Volume Oscillator is a primary proprietary indicator that shows bullish volume accumulation and bearish volume accumulation.  That is, it calculates the difference between volume that is generated as the index advances (buying volume) and volume that is generated as the index pulls back (selling volume).  SBV Oscillator is the main indicator that provides the "go long" and "go short" triggers.  When the SBV Oscillator crosses above the -33% red trigger line it signals "go long", and when it drops below the +33% red trigger line it signals "go short".

Momentum Advance Decline Volume Ratio  - Momentum A/D volume ratio takes into account the actual number of shares that traded in the advances and declines volume segments for a given bar.  Advances momentum volume, for example, reflects the actual volume of those stocks that presently belong to the advances group.

Advance/Decline Ratio - The A/D ratio is calculated by dividing the number of stocks that advanced in price for the day by the number of stocks that declined in price for the day.

McClellan Oscillator - For more on the McClellan oscillator please go to McClellan Oscillator Primer.

TRIN - For more on the TRIN index please go here

MVO - Market Volume Oscillator - The MVO is based on the PVO (Percentage Volume Oscillator) and Stochastics, a popular price-based technical indicator. Combining the power of two different indicators in one provides a means to analyze price and volume at the same time.  The PVO measures the relationship between two volume moving averages (VMA) by revealing the volume surges (abnormal volume activity) that may lead to a trend reversal.  It is commonly known that large volume surges are generated as a result of greedy buying or panic selling.  The larger the volume surge is during a price move up, for example, the more that greedy buying is taking place.  Conversely, the larger the volume surge is during a downward price move, the more extreme is the panic selling.  In the majority of cases, heavy greedy buying and extreme panic selling lead to a shift in supply and demand and changes in a market's mood and trend direction.  Thus, PVO describes the magnitude of greedy selling and panic selling.  The MVO comprises the PVO that is further smoothed/formed via the Stochastics equation giving the MVO additional predictive power.

MACD 18/40/20 - This is a price based indicator where signals are generated from bullish or bearish crossovers from the 18 day Exponential Moving Average (EMA) and 40 day EMA.  These crossover signals help reduce the number of false signals generated by the SBV Oscillator.  For more on the MACD indicator please go to MACD Primer.

Chaikin Money Flow (CMF) -  Developed by Marc Chaikin and is based on the Accumulation/Distribution Indicator, which defines the degree of buying or selling pressure.  The CMF is calculated as the sum of Accumulation/Distribution over specified period divided by sum of volume for the same period.

Volume Accumulation Oscillator (VAO) -  Shows the cumulative volume of the day adjusted by price.  VAO belongs to the group of volume/price indicators.  If the closing price of a stock or index is above the mid-point of the day's trading range, all of the volume is assigned to the buyers, but if the closing price is below the mid-point of the day's trading range, all of the volume is assigned to the sellers.  That is, the VAO assigns volume according to the relationship between the closing price and the average price for the day.  VAO is considered to be more sensitive to the volume-price relationship than the On Balance Volume indicator.  Like OBV, the VAO can be used to confirm a trend, and a divergence of the price direction as compared to the VAO may indicate a change in market sentiment and a near-term trend reversal.

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