Top Advisors Corner

Martha Stokes: How to Use Volume Volatility to Determine Breakouts

Martha Stokes

Martha Stokes


Chaikins Money Flow as a Volume Volatility Indicator

Chaikins Money Flow CMF is commonly used as a momentum indicator, however it is also an excellent volatility indicator that enables technical traders to evaluate volatility or lack thereof during Trading Range conditions which is the hardest of all price action to trade.

Trading Range price action is becoming far more common than it used to be. This is due to the changes of market structure, with institutional large lot transactions and smaller funds using Volume Weighted Average Price VWAP. Trading Ranges are wide sideways price action that has inconsistent highs and lows, and are the pattern that occurs when the market lacks leadership from the largest funds. High Frequency Traders HFTs also create Trading Range patterns when they dominant price action.

The goal for technical traders is to be able to anticipate when the breakout is likely to occur, and what direction the breakout will take. This requires analysis of all three pieces of data available from the market data which are Price, Quantity, and Time. By using indicators that include all three pieces of data in their formulas, it is easier to determine the direction of the breakout and when the stock is poised to breakout.

This provides more time for technical traders to make decisions regarding their strategies to use for the stock. It also allows more time to evaluate risk versus point gain potential, and duration of the trade hold time.

IBM first shows high volatility in volume as the stock moves up during March and April. This warns that even though price is still moving up, profit taking is occurring and beginning to impact volume. The higher the volatility the more likely a topping action is underway, either for a short term correction or a longer term. Tops tend to develop on rising volatility on volume. Price continues up, but volume volatility on the downside warns technical traders early of the top.

For bottoms the opposite is true. Volume volatility will disappear and CMF will often shrink to a narrow range, and waver around its center line. This warns early that a Shift of Sentiment™ is underway and sellers are losing control to the upside. Volume shifts quickly as price moves up. Shift of Sentiment patterns are easy to see with CMF, and are useful to quickly and easily see where the heaviest concentration of larger lots reside. Contrarian patterns to price are a key early warning signal that price will reverse soon, and often suddenly.

For triangles the Shift of Sentiment pattern as shown above dictates the direction the stock will most likely take, allowing for earlier strategy decisions prior to the breakout. 

Summary:

As CMF shrinks and wavers around its center line, a new breakout is being staged. The smaller the CMF pattern, the stronger the breakout will be. Thus monitoring this easy to read indicator helps guide breakout traders not only for when a breakout is about to occur, but also the magnitude of the breakout.

CMF as a volatility indicator will be contrarian to price action much of the time during highly volatile market conditions. This is its most useful aspect for technical analysis. By recognizing the contrarian and Shift of Sentiment patterns, traders can anticipate the breakout with far more accuracy.

Trade Wisely,

Martha Stokes CMT
www.TechniTrader.com
info@technitrader.com