Volume Flow Indicator – Strategy, Rules, Settings, Returns
Navigating the ever-changing world of financial trading can be tough, which is why traders are always seeking better tools to improve their technical analysis — one such tool is the volume flow indicator. What do you know about this indicator?
The Volume Flow Indicator is a complex volume-based technical indicator designed to spot market trends and potential reversals by analyzing both the price action and volume flows. The indicator is similar to the on-balance volume indicator, but it is more complex and combines several factors, including volatility coefficient, volume, and price movement, to assess buying and selling pressure. Its signals include centerline crossovers and divergences.
In this post, we will take a look at most of the questions you may have about this indicator: what it is, how it works, and how you can improve your trading strategies with it. Read on!
Key takeaways
- The Volume Flow Indicator is a volume-based technical indicator designed to spot market trends and potential reversals by analyzing both the price action and volume flows.
- The indicator is similar to the on-balance volume indicator, but it is more complex and combines several factors, including volatility coefficient, volume, and price movement, to assess buying and selling pressure.
- Unlike the on-balance volume, which compares the close price to the previous one, the volume flow indicator compares the change in typical price with a certain threshold — the so-called “cut-off” value — based on standard deviation.
- We show you a backtested Volume Flow trading strategy complete with trading rules and settings.
- For a full list of the best trading indicators, please click here.
What is a Volume Flow Indicator?
The Volume Flow Indicator is a complex volume-based technical indicator designed to spot market trends and potential reversals by analyzing both the price action and volume flows. Created by Markos Katsanos, the indicator is similar to the on-balance volume indicator, but it is more complex and combines several factors, including volatility coefficient, volume, and price movement, to assess buying and selling pressure.
Unlike the on-balance volume, which compares the close price to the previous one, the volume flow indicator compares the change in typical price with a certain threshold — the so-called “cut-off” value — based on standard deviation.
Then, the volume for each period (price bar) is assigned a positive or negative sign depending on whether the current typical price is higher or lower than that of the preceding period. The final step is to get an exponentially smoothed ratio of the cumulative sum of “directed” volume to the average volume over the last 50 periods.
The indicator gives two simple signals: centerline crossovers and divergences. When the indicator rises above the centerline and stays up, the trend is likely up, and when it crosses below the centerline and stays down, the trend is likely down. The stronger signal is the divergence from price action.
A classical divergence is when the price making a lower low and the indicator is making a higher low, there is a bullish divergence, signifying a potential upward reversal. Conversely, when the price making a higher high and the indicator is making a lower high, there is a bearish divergence, signifying a potential downward reversal.
Below is an example of what the indicator might look like on a chart (lower pane):
Volume Flow trading strategy – rules, settings, backtest, returns
We make a trading strategy by using the following trading rules:
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We backtested the strategy using Bitcoin (BTC-USD) 2014 until today.
Here is the equity curve:
Here are the performance metrics and statistics:
- Total Trades: 88
- Time Spent In The Market: 58%
- CAGR: 90%
- Risk-adjusted Return: 155%
- Win Rate: 44%
- Average Win: 31%
- Average Loss: -5%
- Max Drawdown: -70%
We provide the code for the strategy (Amibroker):
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CLICK HERE TO SEE ALL 400 ARTICLES WITH BACKTESTS & TRADING RULES
How does the Volume Flow Indicator work?
The volume flow indicator works like the on-balance volume indicator, but unlike the on-balance volume, which compares the close prices of adjacent bars to assign a positive or negative sign to the volume, the volume flow indicator compares the change in typical (median) price with a certain threshold — the so-called “cut off” value — based on standard deviation. It then assigns positive or negative to the volume for each price bar based on whether the current typical price is higher or lower than that of the preceding period.
Finally, an exponentially smoothed ratio of the cumulative sum of “directed” volume to the average volume over the last 50 periods is obtained.
One unique thing about the indicator is that it uses a volatility threshold to take into account minimal price changes and another threshold to eliminate excessive volume. Also, the indicator accommodates only the latest 6-month volume action and not the entire data loaded in the chart. In terms of signals, the indicator helps to identify market trends and potential market reversals.
When the indicator is above the centerline (the zero line) it indicates an uptrend, and when it is below the centerline it indicates a downtrend. Market reversals are shown by the indicator’s divergence from the price action. For instance, when the price making a lower low and the indicator is making a higher low, it implies a bullish divergence, which could signal a potential upward reversal.
On the flipside, when the price making a higher high and the indicator is making a lower high, it indicates a bearish divergence, which could signify a potential downward reversal.
Why use a Volume Flow Indicator in trading?
You use a volume flow indicator in trading because it shows you changes in volume and the trend in volume, both of which are leading indicators that help you know what the price is doing and how it might move next.
Increasing positive values (values above the zero centerline) of the volume flow indicator can signal accumulation, which is followed up by an uptrend, while negative values (values below the zero centerline) may signal a distribution plus a downtrend that follows. You can also use divergence signals to anticipate market reversals.
What are the benefits of the Volume Flow Indicator?
The benefits of the Volume Flow Indicator include:
- The indicator helps in identifying volume changes — positive values may indicate accumulation, while negative values may signal distribution.
- It is useful for monitoring volume trends — increasing volume shows the momentum behind the price action
- It can be used to study market trends based on where it lies relative to its centerline
- Its divergence from the price swings can indicate potential market reversals.
- It may also help improve the performance of other indicators and analysis tools.
How do you interpret the Volume Flow Indicator?
To interpret the volume flow indicator, you have to understand the two simple signals it generates — centerline crossovers and divergences. Centerline or zero-line crossovers refer to the indicator rising above or falling below the centerline. When the indicator rises above the centerline and stays up, the trend is likely up, and when it crosses below the centerline and stays down, the trend is likely down.
The divergence from price action is a stronger signal than the crossovers. When the price making a lower low and the indicator is making a higher low, there is a classical bullish divergence, signifying a potential upward reversal. Conversely, when the price making a higher high and the indicator is making a lower high, there is a classical bearish divergence, signifying a potential downward reversal.
What is the formula for the Volume Flow Indicator?
The formula for the Volume Flow Indicator is too complex and complicated. It combines several factors, including volatility coefficient, volume, and price movement. Here’s how Markos Katsanos, the creator of the indicator, wrote the Amibroker code:
Period = Param(“VFI Period”, 130, 26, 300, 10 );Smooth=Param( “SMOOTH”, 3, 1, 10, 1 );MAP=Param( “MA Period”, 30, 20, 100, 10 );Coef = 0.2;VCoef = Param(“Vol Cutoff”, 2.5, 1, 5, .5 );inter = log( Avg ) – log( Ref( Avg, -1 ) );Vinter = StDev(inter, 30 );Cutoff = Coef * Vinter * Close;Vave = Ref( MA( V, Period ), -1 );Vmax = Vave * Vcoef;Vc = Min( V, VMax );MF = Avg – Ref( Avg, -1 );VCP = IIf( MF > Cutoff, VC, IIf ( MF < -Cutoff, -VC, 0 ) );VFI1 = Sum( VCP , Period )/Vave;VFI =EMA( VFI1, smooth ); MAVFI=MA(VFI,MAP);dynamic_color = IIf( VFI >= 0, colorGreen, colorRED ) ;Plot( VFI, “VFI(” + PERIOD + “)”, dynamic_color, styleThick );Plot( MAVFI, “”,colorGREEN, styleDashed );PlotGrid( 0, colorBlue );
Basically, the indicator compares the change in typical price with a certain “cut-off” value — based on standard deviation. Depending on whether the current typical price is higher or lower than that of the preceding period, the volume for each period (price bar) is assigned a positive or negative. And finally, an exponentially smoothed ratio of the cumulative sum of “directed” volume to the average volume over the last 50 periods is obtained.
Can the Volume Flow Indicator predict price trends?
Yes, the volume flow indicator can predict price trends but not all the time. It depends on market conditions. But generally, the position of the indicator line relative to its centerline can be used to identify the price trend — when the indicator rises above the centerline and stays up, it means that there is positive price momentum and the trend is likely up.
Likewise, when the indicator crosses below the centerline and stays down, it means that there is negative momentum in the market and the trend is likely down.
How to set up the Volume Flow Indicator?
To set up the volume flow indicator on your trading chart, check whether your trading platform has a built-in volume flow indicator. If it doesn’t, you will have to get a custom volume flow indicator for the platform and install it. When you’re done, go to the indicator section of the platform, search for the indicator, double-click on it to grab it, and then, drag it to your chart.
Now, a box opens up for you to input your preferred settings. Do the needful, and the indicator is ready for use.
Is the Volume Flow Indicator suitable for beginners?
No, the volume flow indicator may not be suitable for beginners given how complex the calculation is. But beginners who can keep their trading approach simple, formulate great strategies with the indicator, and stick to their simple rules can make use of the indicator without knowing how it is calculated or what it measures.
What matters is having a strategy with clear entry and exit criteria and a risk management plan, and then, executing the strategy consistently — the rest is statistics.
What are common Volume Flow Indicator strategies?
The common volume flow indicator strategies include:
- Trend-following strategies: These are strategies that look for trades in the direction of the trend. The volume flow indicator can help to identify market trends for such trades.
- Pullback reversals: This involves looking for the end of pullbacks so as to ride the next impulse swing. The volume flow indicator’s divergence signal can be helpful in this strategy.
How does the Volume Flow Indicator compare to other indicators?
In comparison to other indicators, the volume flow indicator is a long-term, volume-based indicator that helps to show the trend in volume and how it affects the price movements. It is a volume-price momentum indicator.
Unlike the RSI, which is a price-based momentum oscillator, the volume flow indicator uses both volume and price data, and it gauges long-term momentum due to the long period (130) used in its calculation.
What are the limitations of the Volume Flow Indicator?
The limitations of the volume flow indicator include:
- It makes use of volume data and, therefore, cannot be used in markets, such as the spot forex market where the volume data is not available.
- Since it is based on historical volume data, it can lag behind the price action.
- It may be prone to whipsaws when the market is too choppy.
- It cannot be used as a standalone trading strategy
Can the Volume Flow Indicator be used in day trading?
Yes, the volume flow indicator can be used in day trading if it is used on the right timeframe. Day trading often requires you to perform your analysis on an intraday timeframe, such as the hourly, 30-minute, or 15-minute timeframe. If you set up your volume flow indicator on any of these intraday timeframes, you can use it to day trade.
However, the effectiveness of your trading will depend on the performance of your strategy.
How to use the Volume Flow Indicator in different markets?
To use the Volume Flow Indicator in different markets, you have to study the various markets to know how they move and the strategies that can work well. Then, you will have to formulate different strategies with the indicator and backtest them on the different markets.
You may find that a different setting of the indicator or timeframe will work in each market.
What are the best time frames for the Volume Flow Indicator?
The best time frames for the volume flow indicator will depend on the market you’re trading and your trading style. If you are day trading, the hourly, 30-minute, and 15-minute time frames are the common options.
But if you are swing trading, the 4-hourly and daily time frames may be your best options. However, the best way to know the best time frame for your trading style and the market you’re trading will be to backtest the different timeframes for that style of trading.
How does the Volume Flow Indicator signal buying opportunities?
The volume flow indicator signals buying opportunities in two ways: the centerline crossover and the bullish divergence. When the indicator crosses above the centerline and stays there, it means that the market is likely trending upward, so you can go long.
Also, if the market has been going down and forms a bullish divergence — the indicator makes a higher low when the price makes a lower low — it is a signal to buy.
How does the Volume Flow Indicator signal selling opportunities?
The volume flow indicator signals selling opportunities via the centerline crossover and bearish divergences. When the indicator crosses below the centerline and stays there, it means that the market is likely trending downward, so it is an opportunity to sell.
Also, if the market has been going up and forms a bearish divergence — the price makes a higher high while the indicator makes a lower high — it is a signal to sell.
What is the history of the Volume Flow Indicator?
The history of the volume flow indicator can be traced to 2004 when Markos Katsanos, a member of the Technical Securities Analysts Association of San Fransico (TSAAF), introduced the indicator in the June 2004 issue of Technical Analysis of STOCKS & COMMODITIES magazine.
In a subsequent article, he showed some testing results comparing the indicator with the on-balance volume and price momentum indicators, with the volume flow indicator performing far better than others.
Can the Volume Flow Indicator be customized?
Yes, the volume flow indicator can be customized to suit the trader’s strategy and preferences. By default, the indicator is meant to show long-term volume and price trends, but a trader can change the settings and even the logic to portray short-term market activities.
For instance, it can be customized to show short-term swings.
What software supports the Volume Flow Indicator?
Most trading software supports the Volume Flow Indicator. Examples include thinkorswim, TradingView, Amibroker, and Multicharts. Even when it is not built into the trading software, you can get a custom-made volume flow indicator for the platform by coding one yourself or paying a professional to do that for you.
How to combine the Volume Flow Indicator with other tools?
To combine the Volume Flow Indicator with other tools, you should first try to understand how the indicator works so you know the other tools that can complement it. Since the indicator shows volume and market trends, you can combine it with price action analysis tools, such as trendlines, chart patterns, and candlestick patterns.
For instance, a reversal candlestick pattern can confirm a divergence signal from the indicator.
What are common mistakes using the Volume Flow Indicator?
The common mistakes using the Volume Flow Indicator include:
- Trading without a robust trading strategy that can show clear entry and exit criteria
- Not analyzing the price action before entering a trade
- Not combining it with other analysis tools or indicators
- Not considering market conditions before trading
- Trading without a risk management plan
How do professionals use the Volume Flow Indicator?
Professionals use the Volume Flow Indicator to understand volume changes when analyzing the markets. The indicator helps them to assess the volume behind various price moves so they can anticipate when smart money is accumulating or distributing their positions in the market.
It is one of the useful tools in their toolbox — they never use it alone.
What are advanced techniques for the Volume Flow Indicator?
Some advanced techniques for the volume flow indicator include algorithmic trading and portfolio management. Algo traders can formulate good strategies with the indicator and create trading algos based on the logic of the strategy.
This makes it easy to backtest the strategies across different timeframes and markets. Some traders may also use the indicator to guide their portfolio management — buying only assets where the indicator is above the centerline and using the divergence signal to know when to offset their positions.
Is the Volume Flow Indicator reliable in volatile markets?
No, the Volume Flow Indicator may not be reliable in volatile markets, but it depends on how long the volatile market lasts. If it is short-lived, the indicator may absorb it without altering its signal architecture since it has a long-term lookback period.
But if the volatile market lasts for a long time, it can affect the indicator’s signals.