FRED GOODMAN'S KEY INDICATORS FOR INVESTMENT SUCCESS
Price-Volume Charting
Monday, November 26, 2001
Updated Tuesday, July 22, 2004
Fred Goodman

Over twenty 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.

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: Long-Term Price/Volume Charting

: Normalized Price/Volume Charting
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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 market action.

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 basics

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.
Basic price/volume lines

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 basic sell loop

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 basic buy loop

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.

The remove-one-day rule

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.

All 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.


Continuation loops

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.

The 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 situations.


Other trend continuations

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

Springs

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 coils."

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)

Stars

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 on X-axis)

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 me via email.


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 Fred is 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.