VOLUME SPREAD ANALYSIS
Friends
For me TA is a passion. I have been experimenting a lot on various aspects of TA. It has
been a good learning experience. Sharing my experiments was a bigger learning
experience. Truly, unlike sharing money sharing knowledge only leads to further
expansion of knowledge.
A few months ago I came across a thread on “Volume spread Analysis” in the Traders
laboratory forum. Tough I did not understand much the seeds of interest were sown. Thus
began a new chapter in my TA journey.
I had posted some charts based on my work on this. A few had shown interest on this
especially our esteemed Asish. So we will begin a discussion on the “Volume Spread
Analysis”. I request other knowledgeable members to add their bit to this discussion so
that we have fruitful learning experience.
Calling VSA as advanced strategy may be controversial. But the concept is rather new
and is gaining wide popularity. Hence we will consider it as advanced strategy.
Regards
karthik
Note: As we know this will be a restricted thread. Those who cannot post their doubts can
still posts queries in my other threads and genuine queries would be answered there.
Good post even will be copied on the main thread. Now that the awareness on the
reputation points has grown, we hope more members will be able to post in this thread.
Some background notes……..
Once the seed of interest were sown hours were spent searching the net and watching
clips on Youtube. The journey was full of obstacles. There was hardly any clear cut
information available. Most were sales talks with sketchy information. Then hours were
spent studying the charts and formulating rules. The rules were coded to check the
validity of these rules. Some Traderji friend stepped in and there were some real time
checks for these rules. Thus we came up with our own interpretation of the “Volume
spread analysis”.
Please do not start comparing my description with the ones that may be available from
the net. I have used some basic stuff from Tom Williams’s book and have built on it.
Here we are not trying to clone the Trader Guider system.
KARTHIK MARAR
VOLUME SPREAD ANALYSIS
The foundations for volume spread analysis were laid by R.Wyckoff way back in the
early 1930s. Wyckoff was supposed to have made fortunes with his principles.
Wyckoff stared with a premise that price / volume / Time could provide a picture of
the demand and supply from smart money (he called the smart money ‘composite
man’). We will come back Wyckoff later in the thread. It would be nice to look at
Wyckoff methods time to time as his work is the basic one and others have built on
it.
Wyckoff had three basic principles or..say.. laws
Price and volume
Cause and Effect
Effort and Result
The current day VSA available in the market still relate to these tenets.
Much later in the 70s Tom Williams who worked with a syndicate (read… Smart
money) for 15 years, developed on the Wyckoff’s work and came up with Volume
Spread Analysis and later commercialized it. (The critic would say ..why
commercialize it, he could have made money himself.. ). Now many more
companies offer their own concoction of VSA, hawkeye traders and genie software to
name a few.
Tom William’s VSA basically ignores the open of a bar and uses high, Low and Close.
This is where it basically differs from classical candlestick analysis. Most commercial
vendors claim to use more than 300 indicators to analyze each bar. I have seen that
some of the VSA vendors use other indicators though not explicitly.
One thing is certain that the availability of basic information on VSA is scarce. I have
come across much discussion on other forums on VSA. However most revolve around
commercially available packages. Our intention in this thread will be to explore the
basics so that each one of us can arrive at our own convenient VSA analysis.
Now it is time to move on ….
I know most of you are eager to get straight into the core of VSA. But let us lay some
foundations before building the blocks of VSA. First thing is of course to understand a
little more about working of Smart Money (hereafter we will just use the term SM to
indicate Smart money).
The SM basically moves the market in four phases as follows
1. Accumulation
2. Markup
3. Distribution
4. Mark Down
Most of you may be fully aware of these. Still we will look at these phases more in
details as this would help us to understand the SM operation better which in turn would
give a better perspective to VSA.
KARTHIK MARAR
VOLUME SPREAD ANALYSIS
There will not be any demand for something when there is plenty of it available and
nobody wants it. As the availability decreases and more people want it then the demand
increases. So the first thing the SM does is find something that is available a plenty and
cheap. The next step is to create a scarcity of the same and get people interested in it
which in turn generates the demand. This is first phase which is Accumulation.
Accumulation
Accumulation is a process through which the SM acquires a large quantity of the stock at
the lowest possible price. Accumulation is a subtle, sophisticated and sly process of
cornering a huge quantity of the stock that makes the following phases possible and
worthwhile. Once a large quantity has been absorbed the number of floating stock
reduces and the demand increases. This makes possible the next phase Markup.
Accumulation normally takes place in congestion areas. Congestion area are mostly
sideways range bound movements where the stock appears to have no interest to either
move up or move down. The SM ensures that the stock is contained below a certain
upper level which is the supply area. At the same time the SM also supports the prices
above a certain lower line which is the support area. The stock moves within an upper
resistance or supply area and a lower support area.
The congestion areas are characterized by Indecision. One of the most important
characters of congestion areas is the Low Volume. When most traders are bullish or
bearish the volume is high. Low volumes indicate indecision among the traders on
bullishness and bearishness.
Ah.. Sounds easy…….. Well the problem is that congestion areas are seen in both
accumulation areas as well as Distribution areas ……… oh , Well that is not the only
problem………. There will be periods where no one seems to be interested in the stock…
the pattern of price movement most of time very similar to the congestion pattern…..
So the naturally the question is how one would ascertain if the pattern is really
accumulation in progress……. A little later on this and other congestion patterns…..
KARTHIK MARAR
VOLUME SPREAD ANALYSIS
So the question was …How one checks if the congestion area is really an
accumulation area.
There are a few things to lookout for..
•
First, the indecision should be quite visible. In other words the volume should
be low and quite. No huge volume upsurges. Even if the volume is relatively
higher the range between up day volumes and down day volume should be
narrow.
• Second, the spread of the bars (High – Low) should be narrow.
• Third, the volume should shrink near the support line and expand near the
resistance line.
• Fourth, the stock should be trading in a range for some weeks if not months.
Also you may see some shakeouts in the trading range. The SM would temporarily
drive down the prices below the support line in order to takeout the stop losses and
panic the weak hands into selling. You will see the stock bounces back above the
support line immediately. By this process the SM is shaking out the weak money
from the stock. For most of us it is just a failed breakout. Sometime the stock
instead of bouncing back would continue to drop if there was too much supply. So
trading these breakouts could be tricky.
Also it would a good sign if the stocks trading range is much above the support line.
Normally we would see some of the above signs if not all in the accumulation area.
There are many other patterns which signify accumulation. Some of them are
rounding bottoms, reverse head and shoulder and double bottoms (or “W”) patterns.
Each could be explained in terms of SM activity. However we would go into the
details now. One thing to keep in mind when evaluating patterns is that it is very
important to check the volume pattern as well.
For an example we will look at the chart of HCC where a clear accumulation
indication was seen June 2007
KARTHIK MARAR
VOLUME SPREAD ANALYSIS
A few points about the congestion zone we are looking at for signs of accumulation.
It is important to look at the history of the stock prior to the congestion area.
A few things to look out for….
Has the stock gone through a cycle of accumulation, markup, distribution and
arkdown previously? Were there signs of a selling climax just prior to the congestion?
If so, the SM are really looking out for making another round.
Or the stock has been languishing aimlessly prior to the congestion zone you are
looking at. If so, this area you are looking at is not accumulation at all.
Was the stock enjoying an uptrend prior to the congestion? If so, this could be a re-
accumulation going on here.
Was the stock undergoing a minor down trend (after an up move) prior to the
congestion? Was there a downtrend without selling climax? Then this could mean
there is re-distribution in progress and it may be advisable to look out for sign of
KARTHIK MARAR
VOLUME SPREAD ANALYSIS
distribution.
(If you are wondering what is selling climax.. don’t worry.. we will take it up in detail
later.)
Now we come to the next phase in the game plan of SM, namely “Mark Up”.
Once the smart money has a cornered a huge chunk of the stocks they are ready for the
next move. The idea is to jack up the prices so the SM can fill their pockets. Typically
you will see the low are getting higher. The closes are slowly getting nearer to the high.
The prices are getting higher on lower volumes as there is very less supply. The reactions
happen much higher than the support line.
Then ..the stock shoots through the resistance or supply line with higher volume. For that
matter the stock need not exhibit the characteristics mentioned above. Suddenly it can
just pop out of the congestion zone.
It is better to take note on the volume at this juncture. The volume need not be very high
at all. Since there is no supply (SM have the majority of the floating stock). If the volume
is moderate we should see it coming in strongly soon. Otherwise the move will collapse
and stock would return to the base. We should see a large swift increase in the volume in
case of a genuine breakout. The stock should be closing near the top. Also too much
volume is not good. It would mean too much supply is coming in. Heavy volume with the
stock closing in lower half would definitely mean supply coming in. Typically an 150%
increase in volume with the close near the top would indicate a successful breakout.
The breakout is just the beginning. Then the stock moves up in stages. Each stage would
be an advance at higher volumes and a retracement at lower volumes. The retracement is
mainly due to short term traders booking their profits. The SM also starts the distribution
during the retracement. The point at which the retracement stops become important.
These should be above the previous retracement stops. In simple terms as Saint would put
it the stock is making higher high pivots and higher low points.
We will also see sideways movement during the up move which would be congestion
areas. We need to pay lot of attention to these congestion areas for this could be final
distribution areas before the mark down begins. Also it pays to give attention to volume
during retracement and congestion areas. Increasing volumes near support line and low
pivots indicate problem. If the increase is dramatic then it is time to re-evaluate your
position.
Finally the stock could make a climax run where the price and volume explode. The
shorts run for cover and the green horns rush in not to be left out... like cattle rushing into
a abattoir. Soon rapid markdown starts leaving the weak money holding the bag and he
SM their cash.
Please do note that here we are talking about more of an idealistic picture. In reality it
could be more complex and many a time difficult to decipher. But then practice man one
KARTHIK MARAR
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VOLUME SPREAD ANALYSIS
perfect.
Just enclosing a chart with similar conditions mentioned above.
Now let us come to the third phase in the SM game plan which is “Distribution”.
Distribution is the process where the SM is offloading their accumulated stock at a much
higher price.
It is not very easy to spot distribution. Many a times you will not see any congestion
areas. The UP move may slowly deteriorate and start rapidly deciding after a furl of
heightened activity. The Wyckoff puritans may disagree here.
In mark up phase after the stock has run up for some time you will the volume
diminishing and the spreads narrowing. The angle of ascent becomes lesser and lesser.
The stock trend may even flatten. This would mean that the demand is drying up. The
buyers are not willing to pay a higher price for the stock. Also sellers are reluctant to
offload their positions hoping and waiting for a better price. It is here the SM slowly start
offloading their stock. Much care is taken not to make it visible. Volume is never too
high. Prices are support at certain levels so that there is no panic. Here it is important to
KARTHIK MARAR
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VOLUME SPREAD ANALYSIS
take note of the volume price pattern and angle of ascent. Too steep an ascent is also a
problem. Suddenly you will see the stock dropping down like stone from its high perch.
It is at the top you will see patterns like H&S and double Tops which are distribution
patterns.
Many times it is hard to maintain any semblance of the uptrend continuing and so a
sideways congestion move ensues. The congestion zone will be quite similar to the zone
we discussed earlier for accumulation. You will see the price being supported at some
support level and being contained within a resistance level. The points to take note are the
same ones we talked about in the accumulation zone. Just like in the shake outs in the
accumulation zone you will see a shakeout in terms of up thrust bars. One has to be very
careful trading the breakout from the distribution zone. If it turns out to be the final
climax move you will be left holding the bag. But then the stock may goes for another up
move. Here looking for uptrusts and other weak indication becomes necessary. We will
be talking about these indications later.
In the final climax run the stock explodes in terms of volume and price. Like I said before
the breakout traders , greenhorns rush in and the shorts will run for cover. Then you will
see many Uptrust Bars where distribution takes place with maximum prices. There could
be a series of Uptrusts and then…….BANG….. the stock drops down like a stone.
We now come to final step in the SM game plan, the “Mark Down”. When the SM has
disposed off most of the accumulated stock they start the most dramatic move of
crashing down the prices. Suddenly supply comes in plenty overwhelming the
demand. The price starts tumbling. The spreads dramatically widen. There is panic
selling from investors. But the prices drop so rapidly and most of the investors and
green horns that entered late never get a chance to off load there holdings.
Like the markup phase we will see some rallies in the downtrend. These are more off
reactions. Either the SM themselves try to shore up the price for their last bit of
holding. Day traders, “Value Investors” trying to bottom pick and the green horns
trying to “Average” contribute to these rallies. Our friend Saints calls averaging
“Catching a dropping knife”. I cannot find a better description for “Averaging”. It is
better to note the volume during the rallies. You will find the volume is more on
down days and less on up days. When the rally fails the average investor panic and
start selling and that accelerates the fall.
It may take weeks for the down trend to reach the bottom. The end is generally
indicated by a stopping volume or an absorption volume. The SM may be absorbing
the stocks to start the game again. You would find a High volume bar with long
spread and closing near the top.
It is during the mark down phase you will see rallies like the “Dead Cat Bounce”. Pay
attention to the volume pattern during these rallies.
The mark down phase is the most depressing and cruel part of the SM game plan. By
the end of it the SM would be taking delivery of his brand new E class Benz while the
average investor is scouting for a buyer for his run down maruti.
KARTHIK MARAR
john
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VOLUME SPREAD ANALYSIS
Of course the Markdown phase does offer good opportunities to smart investors who
are adept in short side trades.
But the mark down phase has a silver lining… towards the end it offers the smart
investors many opportunity to enter into some really profitable trades. We will
discuss all these later.
Now that we have a general idea about the SM operation we can step into the world of
VSA.
VSA involves analyzing each bar with respect volume, spread and close. We will ignore
the open. Also while analyzing the bar action we will also keep in mind the general
background of the market.
As a first step let us make some definitions. These are elementary and most of you
understand this. But for the sake of synchronizing our thought I will repeat these here.
Some Basic Bar definitions.
Upbar - A bar would be called a up bar if the close of the bar is above the close of the
previous bar.
Downbar – A bar would be called a Downbar if the close of the bar is below the close of
previous bar.
Spread – Spread is the difference between High and Low.
A wide spread Bar – If the spread of the bar is above 1.8 times the average spread then
we will term it as a wide spread bar. The factor of 1.8 is a tentative one.
A narrow spread bar – if the spread of the bar is 0.8 times the average spread then we will
term in a narrow bar. The factor 0.8 is again tentative.
Note:
The problem of calculating the average spread is that during volatile period the average
spread is high and in non volatile period the average spread is lower. So a bar which
could be termed as a wide spread bar (WRB) in non volatile times could become a
average or even a Narrow spread bar (NRB) in volatile times. For simplicity sake and to
take the discussion forward we will keep the above factors common. At a later stage we
can discuss about methods to arrive at better methods of defining the average which
works at all times.
KARTHIK MARAR
VOLUME SPREAD ANALYSIS
Now let us define some Close positions.
Up close : A close near the High would be termed as a Up close. (Upper 30% of the Bar)
Down close: A close near the Low would be termed as Down close (Lower 30% of the
Bar )
Middle close: A close in the middle would be termed Mid close (between 30% to 70%)
Please note that the values mentioned above could controversial. But for this discussion
we will take these values and move forward.
Now we have some basic tools to analyze the bars.