FRED GOODMAN'S KEY INDICATORS FOR
Monday, November 26, 2001
Updated Tuesday, July 22, 2004
five years of experience have made Fred Goodman the master of
price-volume loops. Now he shares the basics of his most esoteric technical indicator.
Price/volume charting is an unconventional
charting technique that can serve to guide the investor through market-timing
decisions. It was invented by Benjamin Crocker in the 1950's.
It is not perfectly "predictive," in the sense
that, if a particular chart pattern develops, it is a guarantee that the market
will go up (or down) immediately thereafter. Instead, various patterns help the
experienced price/volume chartist estimate the probability of a given
To draw a price/volume chart, you plot points on
a grid with price on one axis and volume on the other -- and then over time you
connect the points with lines. The patterns formed by the lines between the
points generate buy signals and sell signals.
The vertical y-axis is for the price of the stock
or index you are charting. The horizontal x-axis is for the volume. The range of
price or volume, and the spacing between increments, are selected to make the
resulting chart easy to read. There is no significance in the scaling of the
chart other than to promote readability.
The chart will produce a series of lines, zigzags
and loops, and there are several general rules for interpreting their patterns.
Patterns that form may be bullish or bearish
depending upon the predominant direction of the lines making them up.
- Lines moving from the lower left to the upper
right or from the upper right to the lower left are bullish.
- Lines moving from the upper left to the lower
right or from the lower right to the upper left are bearish.
Completed loops are very significant in assessing
the probable direction of the next market move.
- Patterns in the clockwise direction are
associated with bullish moves.
- Patterns in the counterclockwise direction
often precede down-moves.
The rally or decline following such a bullish or
bearish loop may last for days or even months, so there is no way of knowing for
how long. However, it is of considerable value in timing an investment that you
have already decided to make or close for other reasons.
There is logic behind the interpretation of a
loop. Follow along with the next paragraph while studying the sell loop below.
The first day saw the index under consideration
advance sharply on high volume. The line connecting that day's close to the
previous day marked "start", produced a line from the lower left to the upper
right, in the bullish direction. The next day was another sharp advance that
occurred on still higher volume. High volume advances are bullish since they
show good participation behind the advancing prices. On the next day the rally
continued, but on only a slight increase in volume. The direction was still from
the lower left to the upper right and therefore still in the bullish direction.
These three days produced an uptrend line. The next day the index dropped on
much less volume and that was followed by another decline on still less volume.
However, the next day volume picked up while the index dropped again and the
loop was completed, by penetration of the uptrend line. This is a clear-cut
example of a bearish sell loop, but loops are often considerably more complex
and require careful analysis before acting.
A buy loop, as exemplified in the chart below,
operates with precisely the same logic, but in reverse.
The remove-one-day rule
The basic buy or sell loop must include at least
four trading days (the charts above both illustrate five-day loops). For any
loop to be valid, it must be confirmed the day after it is first completed. The
confirmation takes the form of another point that does not reopen the completed
loop. The last arrow in the sell loop above was the confirmation day. The
confirmation day is needed because of a general rule which states:
- If a loop can be destroyed by removing one of
the days involved, it is void and was never a valid signal in the first place.
Here is a chart that at first glance appears to
be a valid, counterclockwise sell loop. But look at what happens if one day is
removed. The dashed lines represent the original loop before the day was
removed. The green line resulted from the removal of that day. Before, there was
a large counterclockwise loop after, there was no loop at all. What does this
say about the market? We must make a bullish inference from (1) the strong
advance, (2) the penetration of the downtrend line, and (3) the overall
direction of the pattern, which is clearly inclining from the lower left to the
upper right -- the bullish direction.
In addition to this example, the remove-one-day
rule is the reason why there can be no loop with fewer than four days since the
removal of any one of the three will destroy a three-day loop. A final
illustration of the rule shows the reason that every loop must be confirmed by
one more day after it is completed.
loops must be confirmed
Removing a single day's closing price and volume
destroyed the loop. This is the same chart that was used to illustrate the
counterclockwise loop above. However, when the indicated day was removed the
green arrow resulted and the loop was opened.
As I have pointed out, a clockwise loop is
considered to be bullish and a counterclockwise loop is considered to be
bearish. There is one exception to this rule.
- A bullish clockwise loop must break the
downtrend line immediately above it, if any.
- A bearish counterclockwise loop must break the
uptrend line immediately below, if any.
Here is an example of a counterclockwise loop
that did not break the uptrend line. It is an example of a
continuation buy loop.
continuation buy loop
Notice that even though the completed loop is
counterclockwise, because the uptrend line was not penetrated, the
pattern is considered to be bullish: a completed continuation buy loop.
Keep in mind that the rules for buy and sell
signals are precisely opposite so the examples above can be used for both
There are several other formations that Crocker called
"trend continuations" that are not seen as often as continuation loops, but they are nevertheless important to keep in mind.
The first is a bullish clockwise loop that starts out with a decline, following
a rally. The loop begins after a high volume advance, and in Crocker's words (edited for clarity), "The continuation formation shown in the chart is
particularly helpful in detecting false reversals. Note that since the reversal
does not start from low volume it is immediately suspect. The whole formation
can be looked at as a confirmation of the original up turn that started the
basic up trend."
Bullish Clockwise False Reversal
Here is the bearish counterpart, which is the mirror image of the bullish pattern.
Bearish Counterclockwise False Reversal
The final trend continuation formation starts out as a counterclockwise reversal,
and once again, in Crocker's words, "Unsuccessful reversal formations,
such as in the chart below, are often helpful in judging breakout direction.
The market tries to break the basic trend, fails to do so and then continues
the move in line with the basic trend."
A true reversal formation would end with a decline that would cross the original
uptrend line at the bottom of the chart, along the red arrow. The false reversal
is a bullish continuation of the basic trend.
Bullish Counterclockwise False Reversal
Here is the bearish counterpart, which is the mirror image of the bullish pattern.
Bearish Clockwise False Reversal
In Crocker's own words: "Spring formations are characterized by alternating
up and down moves at progressively lower volume. An Up Spring is marked by bearish
moves and is generally terminated by a breakout perpendicular to the spring
Furthermore, "The up move from an Up Spring is
generally short term and is usually followed by a sustained down move."
The Up Spring has a general bullish posture. It clearly tilts from the lower
left to the upper right, and the final breakout moves smartly through the oscillations
from low volume to high, again in the bullish direction.
Up Spring (Price on Y-axis, Volume on X-axis)
The Down Spring, on the other hand, starts out with a rally on decreasing volume
and ends with a decline on higher volume -- decidedly bearish. All in all, the
development of a Down Spring and the follow-through of the market afterwards,
is exactly the opposite of the Up Spring as described above.
Down Spring (Price on Y-axis, Volume on X-axis)
According to Crocker, a
star is "a formation that permits a change in trend without a large
excursion in either the price or the volume dimension. Stars come in many
shapes, but they share a common characteristic: to change direction without
moving far on the P/V Chart. Stars seem to have little forecasting power other
than that they indicate a market with no strong trend one way or the other."
Star (Price on Y-axis, Volume
I have tried to cover all the
basic rules and instructions, but there will be important subtleties that will
come up as we go along. Please help by asking questions -- you can send them to
Fred Goodman, CFP, is a fee-only Certified
Financial Planner based in Los Angeles. You can send him your questions and
comments via email at
Fred@MarketMonograph.com. The charts and commentary represent what
thinking about the market and thinking of doing for his own account and for
accounts he manages. There is no guarantee that you will profit from trading as discussed
herein. You may lose money and Fred assumes no responsibility for what you do or
do not do with this information.