|
Jesse Livermore is a name synonymous with trading and short term speculation. Over his lifetime he made (and lost) many millions of dollars. If there is one argument that could be made against his brilliance, that would have to be his frivolous attitude towards money.
In ‘Reminiscences of a Stock Operator’, Livermore makes the observation that increases in volume (such as spikes) can occur under two very different circumstances. According to Livermore, noticeable increases in volume should be evident during the strongest part of a trend and also at the very end (or beginning) of a trend. Unfortunately, identifying a spike in volume is very easy (as described later) but the interpretation of whether it’s a continuation or turning point is sometimes quite difficult.
One way to overcome this particular problem is to take the view that the market could go in any direction after a volume spike. If the subsequent move is likely to be one of a continued sustained trend or a major reversal, any move should be long lasting and offer the opportunity to make some decent returns. The second half of this article shows a basic system for trading volume spikes in any direction – that is, a move up or down is useful, as long as it’s a big move. It is an important caveat, however, that there are many other technical and fundamental analysis techniques which can improve this system dramatically. The downside of a non-directional system is that it is important to recognize that the risk versus reward is often quite high. Looking for a volume spike coinciding with a Wave 5 sell bouncing off a support level for example, could increase your directional accuracy especially if effort was spent cross referencing this type of set up with a Buffet-esque style of value hunting.
There’s plenty more information on how to pick better trades which you can access through your software. Just open up the ‘articles’ menu in your software (click the ‘News Icon’, select ‘articles’) and you can read up on many different confirmation signals. These articles go back for years, and there is a ton of material to work through to help your learning.
click to enlarge
Remember, this resource can be used for any number of searches and it is a fantastic (and completely free) educational aid. Make the most of it!
The entry rules for our volume spike trade are relatively simple. To simplify the process even further, your ProfitSource or HUBB Investor both have pre-computed scans which automatically find stocks that have experienced a major spike in volume over the last few days. The scan specifically looks at a 200-day moving average of volume and will shortlist all shares that experience a day where volume exceeds this amount by 200%.
Entry orders are placed on an ‘on stop’ basis for both a long and short position. A ‘buy on stop’ order is placed at the high (plus a couple of cents for breathing space) of the price bar on which the volume spike occurred. At the same time a ‘sell on stop’ order is placed at the low (minus a couple of cents) of the exact same price bar. If you imagine the market is trending up when a volume spike occurs and that spike is signalling a reversal, the ‘sell on stop’ order would be activated as price falls through the low of the day when the spike occurred. The buy on stop order would then become an initial stop loss order and the trade can be managed according to your trading plan.
The example below should help to illustrate the principals.
click to enlarge
You can see every volume spike (highlighted with a circle on the lower chart) coincides with an entry and exit on the price chart. Of the three trades taken, long and short orders are placed at exactly the same time. The market, therefore acts as a catalyst triggering either order in the direction of the price momentum.
As a stand-alone system the ‘volume spike’ methodology will likely result in several false signals and early stop outs. Another problem in choppy markets is that the volume spike can appear with a large range day. This would increase the distance between entry and exit stops, effectively increasing risk at a time when the market participants are at their most indecisive.
The system is not beyond improvement and would require back testing for the appropriate market to be traded. Several simple adjustments could be added to act as filters and remove some of those inherent problems just mentioned. One suggestion could be to wait for entry around a two-day swing or incorporate a ‘gap’ filter. Placing stops relative to volatility (such as average true range, etc) in order to stay in positions longer would also be an area to investigate further. Whatever you decide, volume anomalies represent smoke, and where there is smoke, there is often also fire.
Stay sharp,
John Jeffery
|