Going With The Flow (Money And Volume)
Using Money Flow To Stay With The Trend
by Markos Katsanos
Avoid impending disasters and stay on the right side of the trend with the volume flow indicator.
In their classic Technical Analysis Of Stock Trends, Robert Edwards and John Magee make an appropriate introduction to my topic.
It is this change in supply and demand that I attempted to detect and quantify with my new indicator, which I call the volume flow indicator (VFI).
Why this new indicator? I was looking at the performance of some stocks that I had sold six to eight months earlier because of short-term sell signals. These same stocks had since doubled in price, or in some cases tripled. Since small, random price movements tend to distort the underlying trend, I thought I'd create a long-term money flow indicator.
THE VOLUME FLOW INDICATOR
The rationale behind VFI is not new, but merely an improvement on Joseph Granville's approach to the classic on-balance volume indicator (OBV). In designing the VFI, I attempted to improve on the following:
- Indicator values
- Historical segment
- Short- and intermediate-term predictive power
- Excessive moves on huge-volume days
- Minimal price changes
- Calculation of the indicator
I devised four different trading systems to test the new indicator's predictive power and compared it with OBV, the buy and hold method, and a price-based indicator. The VFI outperformed them all by a wide margin. All four VFI systems returned more than 150% per year, versus meager gains (at best) or even losses when applying the buy and hold strategy.
Figure 1: ON-BALANCE VOLUME VS. VOLUME FLOW INDICATOR. Until the end of August 2000, the OBV, diverging positively from price and making higher highs at points C and D, deceived traders into long trades. In sharp contrast, the VFI made its last high in January 2000 (point A), long before the Nasdaq peaked. In March 2000 (point B) it changed course and plunged sharply, providing warning of the Nasdaq's trend reversal.
...Continued in the June issue of Technical Analysis of STOCKS & COMMODITIES
Excerpted from an article originally published in the June 2004 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2004, Technical Analysis, Inc.
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