Lockdown time gives us the opportunity to dust up some old stuff and cleanup. Some people found the time to look at some of my old work and shown some interest in them. One such work is the Volatility Trading system for Intraday. This is simple trading system based on bands based on volatility where these bands are used as entry points and trailing stops.
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KarthikMarar Various articles from the authors website, www. What is Volume Spread analysis? Volume spread analysis is a new way of looking at the market.
It is more like the candlestick analysis taking into consideration the volume. However, not all the candle stick rules apply here. The basic premise behind the volume spread analysis is that the market is basically moved by the Smart Money.
The smart money accumulates the stocks at low prices. Then, there begins the process of marking up the price. Then the Dumb Money starts entering the market slowly. The smart money starts passing the ownership of the stocks to the dumb money. This process is called Distribution.
Soon more and more dumb money starts rushing into the market not wanting to be left out of the big rally. Unfortunately the retail traders are the last to get in. Once the process of distribution is complete, the smart money starts rapidly marking down the prices and the dumb money are left holding the stock which was bought at high prices.
At the end the smart money is much richer and they can again start accumulating the stock at lower prices. The cycle continues. This one way explains why the up move moves are slow and the down moves are very rapid. The process of marking up the prices and distribution is a slow process. It takes some effort to get the dumb money interested in buying into the rally.
The mark down process is very rapid as the smart moneys intention is to trap the dumb money. They have to give very little chances to dumb money which is generally slow in reacting to exit. VSA attempts to read the moves of the smart money by looking at the price, volume and the spread of prices. The foundations for volume spread analysis were laid by R. Wyckoff way back in the early s. Wyckoff was supposed to have made fortunes with his principles.
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 1. Supply and Demand 2. Cause and Effect 3. Much later, in the 70s, Tom Williams who worked with a syndicate read Smart money for 15 years, developed on the Wyckoffs work and came up with Volume Spread Analysis and later commercialized it.
Now many more companies offer their own concoction 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 Markup Distribution 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.
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 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 either to move up or to 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 or demand 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. The problem is that the congestion areas are seen in both Accumulation as well as Distribution areas.
Thats not the only problem; there will be periods where no one seems Author: KarthikMarar www. 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 volume range between up day and down day 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. Sometimes, 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 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 in June 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 lows 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. For that matter, the stock needs 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.
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