Volume Rate of Change: A Simple Guide for Traders

Trading volume is often the silent companion to price trend movements, understanding it can unlock deeper insights into volume analysis, and one tool that helps traders do just that is the volume rate of change trading indicator.

Think of trading volume as the engine behind the average price. When the engine revs up (high volume), the price trend moves faster and becomes stronger. The volume rate indicator acts like a tachometer, measuring how quickly that engine accelerates or decelerates. Traders use this technical indicator to gauge whether a rising or falling volume trend is developing, helping them confirm whether price action is sustainable.

A clear understanding of the volume indicator can be a game-changer for systematic traders, offering a rules-based approach to volume analysis and aiding in more informed, confident decisions.

The volume rate of change measures the percentage change in current volume over a specific period. Typically, it is calculated as the percentage change of the volume between the volume n-periods ago and today. This helps traders understand whether or not volume is changing at a rate that signals an important market move.

The formula for calculating the volume rate of change is:

If the change in volume is positive, it indicates that buying and selling volume is increasing relative to the past. If it’s negative, it signals that low volume may be impacting price trends.

Imagine a stock with a closing price rising steadily for a few days. If the volume indicator also shows a significant positive value, this confirms that the rise in price is supported by increasing trading activity. On the other hand, if the volume indicator shows a negative value, it might suggest that the strength of price movements isn’t supported by volume moving, signaling a potential reversal.

When implementing volume indicators, traders rely on different tools to analyze shares changing hands in the market. Let’s compare the volume rate-of-change indicator with three other powerful technical analysis tools: On-Balance Volume (OBV), Chaikin Money Flow (CMF), and the basic volume indicator.

1. VROC vs. On-Balance-Volume (OBV)

OBV is a technical trading indicator that adds volume on up days and subtracts it on down days, measuring whether a stock is being accumulated or distributed.

• Volume indicators help traders analyze volume activity, but VROC focuses on how quickly volume changes.

• OBV tracks volume moving as a cumulative measure, while VROC highlights the speed at which volume changes.

Use Case: VROC is ideal for spotting volume spikes, while OBV helps identify trading opportunities.

VROC and OBV on a 4-hour Microsoft Corporation (NASDAQ: MSFT) chart.

2. VROC vs. Chaikin Money Flow (CMF)

CMF combines price and volume data to measure accumulation or distribution.

• VROC solely focuses on volume data to measure buying momentum.

• CMF oscillates between -1 and +1, indicating stronger or weaker money flow.

Use Case: VROC works well for identifying trend acceleration, while CMF is better for gauging buying and selling volume.

3. VROC vs. Volume Indicator

The basic volume indicator simply measures the total number of shares traded during a given period.

• VROC highlights how fast volume increases or decreases relative to past levels.

• The use of volume indicators in trading helps confirm trends and validate momentum shifts.

Use Case: Traders can interpret volume more effectively with VROC than with a simple volume profile.

In regards to systematic trading, relying on clear, objective rules is crucial. Discretionary traders often let emotions guide them, leading to inconsistent results. Using the volume indicator within a structured system helps eliminate emotion and subjectivity from decision-making.

For instance, when backtesting a systematic strategy, you may discover that trading signals generated by VROC, combined with technical analysis tools, result in more reliable trades.

Traders can eliminate the uncertainty of discretionary trading, leading to more reliable, systematic strategies by incorporating VROC into a pre-defined set of rules, .

Like any technical analysis tool, VROC has limitations:

• Over-Optimization: Fine-tuning VROC’s parameters too much can lead to misleading results in live markets.

• False Signals: Just because the indicator shows an increase in volume doesn’t mean the price will follow.

• Ignoring Market Conditions: The volume indicator is most effective in trending markets, while volume can signal potential noise in sideways markets.

Mitigating Challenges

Traders can minimize these issues by combining VROC with technical analysis tools like RSI or MACD. Additionally, use volume indicators strategically based on market conditions and conduct extensive backtesting.

Now that we understand how the VROC works let’s explore some actionable strategies for using it in your trading system:

1. Confirm Trend Strength: Use VROC to confirm an uptrend or downtrend’s strength. If VROC rises with the price, it signals that volume supports the move. If VROC falls while the price rises, this may indicate a weakening trend.

2. Spot Breakouts: Look for VROC spikes during breakout situations. When a stock breaks out of a trading range, an increase in VROC can confirm real market interest behind the move. This can help filter out false breakouts.

3. Identify Reversals: Watch for sharp changes in VROC as the price reverses. A strong positive VROC, when the price is reversing upward, could indicate the beginning of a new trend, while a negative VROC in a downtrend might signal a short-term pullback.

4. Combine with Other Indicators: Use VROC with moving averages, RSI, or MACD to get a broader market picture. This multi-indicator approach can increase the probability of making correct trading decisions.

5. Fine-Tune the Settings: Test different time periods for your VROC calculation to find what works best for your chosen stock or market. Shorter periods are more sensitive, while longer ones smooth out daily fluctuations. 

The Volume Rate of Change (VROC) is a powerful, yet often overlooked tool in a stock trader’s toolkit. Traders can confirm trends, spot reversals, and validate breakouts with greater confidence by understanding how volume is changing, and using it within a systematic trading approach.

For traders focused on building consistent, rules-based strategies, integrating the VROC into your system can provide a distinct edge. But remember, the true power comes when the VROC is part of a broader, well-tested strategy that doesn’t rely on emotion or discretion.

If you’re ready to improve your trading system and avoid the pitfalls of discretionary decision-making, apply now to The Trader Success System. It’s designed to help you build a trading strategy that’s as reliable as the data it’s based on.

Remember – You are only one trading system away!