Volume analysis in the stock market is crucial. Understanding the flow of volume provides insights into market dynamics that price alone can't reveal. While I don't utilize volume analysis often in my daily routine, there's one volume indicator that has consistently proven its worth: the Chaikin Money Flow (CMF).
Before we get to CMF, it's important to understand how volume analysis has evolved. When I was getting started in the early 2000s, volume analysis made sense because the trading environment was different. Traditional volume indicators were effective in a market less influenced by dark pools and electronic trading. But as these advancements have changed the landscape, traditional volume indicators seem to have lost some of their edge.
S&P 500 with Chaikin Money Flow. Source: StockCharts
Having said that, I actually do use some volume analysis in my work, mostly in the form of volume-based indicators that look for volume trends. Legendary market strategist Joe Granville made great strides when we created On-Balance Volume (OBV) in the 1970s. This was revolutionary for its time, measuring volume based on whether the day ended higher or lower than the previous day. Think of it as a cumulative advance-decline line for volume. However, it had its limitations—it treated an entire day's volume as either bullish or bearish, which isn't ideal.
That's where Mark Chaikin made a leap forward with the Chaikin Money Flow. This indicator evaluates the closing price relative to its high-low range and quantifies the daily volume's bullish or bearish nature. If we close near the day's high, it suggests bullish volume; near the low, it's bearish. The indicator tracks this daily volume reading over time, providing a nuanced view of volume trends.
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When examining the S&P 500 using CMF, two main applications stand out. First, volume trends over time reveal accumulation and distribution patterns. Understanding whether the market is being accumulated or distributed can offer powerful insights into future price movements. For instance, the CMF was exceptional at identifying key turning points in August, March, and July of 2024.
The second crucial application is spotting divergences. A bearish divergence, where the market price keeps climbing but CMF starts trending downward, is a red flag. This discrepancy suggests that while prices are rising, there's an underlying sell-off—indicating that some investors are offloading their holdings despite the bullish price action. We saw this clearly before significant downturns in previous months and should watch for it moving forward.
As of October 2024, we haven't yet seen a bearish divergence, but staying vigilant is key. The current bullish trend might still be robust, but watching for CMF to turn lower could signal that we're nearing a market top. Recognizing these signs early—before the broader market catches on—can be incredibly advantageous.
So, what do you think about the Chaikin Money Flow? Does it offer valuable insights that align with your trading strategies? Drop a comment, and let's discuss. And remember, it's always a good time to own good charts.
RR#6,
Dave
Disclaimer: This blog is for educational purposes only and should not be construed as financial advice. The ideas and strategies should never be used without first assessing your own personal and financial situation, or without consulting a financial professional.
The author does not have a position in mentioned securities at the time of publication. Any opinions expressed herein are solely those of the author, and do not in any way represent the views or opinions of any other person or entity.