Pinpointing Volatility Dynamics

IDENTIFYING VOLATILITY
If you take a look at the price action in the June 2005 mini-sized Dow Jones Industrial Average (DJIA) in the last few weeks of April 2005, you'll see a good example of volatility.

·The June 2005 mini-sized Dow closed on Friday, April 15, 2005, at 10083, down 170 points on the day, 492 points off its weekly high and 787 points off its monthly high.
·The June 2005 mini-sized Dow closed on Friday, April 22, 2005 at 10188, down 38 points on the day, 398 points off its monthly high and 189 points off its monthly low.

In general, the daily trading ranges during these weeks were 100 points up one day and 200 points down the next day. The trend becomes unpredictable, but an increase in volume becomes predictable during volatile trading days. Volume is the driving force of the market's dynamics: real time and historical. Traders can reap significant benefits by adding a tool such as "Volume at price" to their war chest of trading paraphernalia. By using such a tool you gain transparency to price action. You know the volume at the high of the day, or the volume of the price that triggered the selloff.

ADVANTAGES OF TRANSPARENCY
There is a plethora of trading tools available, both fundamental and technical, to analyze the behavior of the market: pivot points, yesterday's high/low and/or close, key reversal number, and more. The common thread of all these trading tools is that each price on any time frame will have a volume number associated with it. During high-volatility days, having a trading tool that pinpoints the historical volume distribution of the trading ranges can give traders confirmation for their trigger points. Using historical data to gauge the reliability of real-time data is a common tool that has been used in many different forms for a number of years, because "history repeats itself."

HIGH VOLATILITY DAYS
Here are examples of the high-volatility days for the June 2005 mini-sized Dow:

·The June 2005 mini-sized Dow closed on Friday, April 15, 2005, at 10083, down 170 points on the day, 492 points off its weekly high and 787 points off its monthly high.

The market was under selling pressure all week. New weekly lows and monthly lows were being set almost daily. Traders first worried about higher interest rates and then switched gears and worried that the economy might be slowing. No matter; they found reason to sell and did. The standard bar chart in Figure 1 shows a congestion area of 10580 ­ 10380.

Figure 1: This standard bar chart shows a congestion area.

On April 14­15, 2005, the market sold off once it broke the 10380 area. The week vs. day chart in Figure 2 pinpoints and compares the historical volume distribution for the trading range of the week as well as for Friday's trading range. In the display you see:

1 The high and low price for the week's trading range (left-hand side of the rectangle)
2 Cumulative volume at each price for the week (left-hand side of the rectangle)
3 Numerically and visually displays of Friday's severe selloff (right-hand side of the rectangle)
4 The high-volume distribution 10530-10400 for the week's trading range
5 A confirmation that Thursday's high at 10429 meets resistance right at the lower band of the high volume area
6 Thursday's closing price at 10253 (blue horizontal line)
7 A confirmation that Friday's high at 10273 met resistance (R1) at the first high-volume area above Thursday's closing price.

Figure 2: This week vs day chart pinpoints and compares the historical volume distribution for the trading range of the week as well as for Friday's trading range.

·The June 2005 mini-sized Dow closed on Friday, April 22, 2005, at 10188, down 38 points on the day, 398 points off its monthly high and 189 points off its monthly low.

The market swung both ways in a big manner. The conflicting economic reports and the slew of corporate earnings put new meaning to the word volatility.

The standard chart in Figure 3 shows the week's trading range during the high-volatility week trading sessions (April 18­22).

Figure 3: Trading week, April 18-22.

The week vs. day chart in Figure 4 pinpoints and compares the historical volume distribution for the week's trading range and for Friday's trading range. In the display you see:

1 The high and low price for the week's trading range (left-hand side of the rectangle)
2 Cumulative volume at each price for the week (left-hand side of the rectangle)
3 The high and low price for Friday's trading range (right-hand side of rectangle)
4 The cumulative volume at Friday's price (right-hand side of rectangle)
5 The high volume distribution are for the week's trading range at 10150-10070.

Figure 4: The week vs. day chart pinpoints and compares the historical volume distribution for the week's trading range and for Friday's trading range.

Figure 4 shows how historical high volume areas can give traders key market numbers. Figure 5 shows how the market used the upper band of the high volume area of 10150 ­ 10070 to establish its daily lows on Monday, April 25, 2005, and Tuesday, April 26, 2005.

Figure 5: Standard bar chart; Monday, April 25 and Tuesday, April 26.

Trading ranges are not random, even during volatile trading days. Each price has a volume number. Historical volume at price deciphers the dynamics of price action. By adding volume at price to your war chest of trading tools, you can make more confident trading decisions. After all, a picture is worth a thousand words.

Lisa Erdmier has been a student of technical analysis for 25 years and began her involvement in commodities and equities as a technical analyst for Merrill Lynch. She is president and cofounder of www.chart-ex.com, a free website that provides traders with an intuitive volume at price trading tool for derivatives.

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