How to Interpret the Volume Zone Oscillator

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How to Interpret the Volume Zone Oscillator

Walid Khalil first proposed the volume zone oscillator (VZO) in the International Federation of Technical Analysis Journal in 2009, and David Steckler followed up in Technical Analysis of Stocks and Commodities magazine in May 2011. These articles describe a money flow indicator with simple trade triggers and strong links to on-balance volume (OBV).This new tool has gained momentum since then and is now included in many charting packages, but additional testing and experience will be required to adequately assess its potential.

The oscillator categorizes daily volume action as positive or negative. It is positive when the current closing price is higher than the previous closing price and negative when it is lower. The resultant curve traces through relative percentage levels, yielding a series of buy and sell signals based on the level and direction of the indicator. (An Introduction to Oscillators is also available.)

The Formula for Volume Zone Oscillator Is:

V Z O = 1 0 0 V P T V where: V P = volumeposition = X periodEMA ( volume ) T V = totalvolume = X periodEMA(volume) beginaligned &VZO = 100 x frac VPTV &textbfwhere: &VP=textvolume position = X – textperiod EMA (pm text volume) &TV=texttotal volume = X – textperiod EMA (volume) endaligned ​​

The period is 14 by default, however it may be changed after backtesting.

Depending on the session or price bar, the algorithm generates a daily variable “R” that includes an up or down volume reading. Extensive moving averages are used to smooth the VP and TV results, and the final figures are multiplied by 100 to provide a % scale on the indicator panel. When the cumulative R is positive, the oscillator travels higher; when it is negative, it moves lower.

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When the VZO climbs above and holds the 5% level, it indicates a positive trend; when it falls below the 5% level and fails to turn upward, it indicates a negative trend. Bullish trend zones are marked by oscillations between 5% and 40%, whereas bearish trend zones are marked by oscillations between -40% and 5%. Meanwhile, values over 40% indicate that the market is overbought, while readings above 60% indicate that the market is severely overbought. Readings below -40%, on the other hand, suggest an oversold state, which becomes very oversold below -60%.

The indicator panel displays horizontal lines that correspond to relative percentage levels and, when crossed, provide buy and sell signals:

  • SIGNAL TO BUY OR COVER – cross from below to above the -40% line.
  • SHORT SELL OR SHORT SELL SIGNAL – cross from above to below the 40% line.
  • LESSER Purchase OR COVER SIGNAL – cross from below to above the 5% line; nevertheless, every consecutive violation adds a 7.5% buffer zone before the next buy signal.

The VZO may be used with a 14-period average directional indicator (ADX), with values higher than 18 indicating a moving market. When ADX indicates a trend, a 60-period exponential moving average (EMA) is analyzed, with price crossing above the moving average indicating a bullish trend and price crossing below the moving average indicating a bearish trend. Backtesting particular securities should be used to alter and improve these parameters.

To confirm VZO buy or sell signals, look at price patterns and other indications. When bullish and bearish crosses line with two times or larger average volume, volume bars, which are typical on most price charts, give helpful information in this respect, contributing to signal dependability. In addition, watch for OBV to rise when the VZO rises over 50% and decline when it goes below that level.

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An Example

Image by Sabrina Jiang © Investopedia2021

Penn National Gaming (PENN) saw a bumpy rise in the first half of 2015, as indicated in the chart above, before breaking out to a big new high in July. During this time, VZO gave two key purchase signals: in December and in June. Both were preceded by strong uptrends that would have resulted in tremendous gains. The period produces two credible sell signals in February and April, but extra signals in January, May, and June diminish credibility since they occur at the same time as higher prices.

The Bottom Line

The volume zone oscillator takes a novel method to volume-based trend signals, borrowing from the traditional on-balance volume Indicator and including smoothing averages to provide buy and sell signals at various degrees of trend movement.

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