In this article, we will discuss
- What is the Volume Price Trend Indicator?
- What is the Formula for Calculating the Volume Price Trend Indicator?
- How to Interpret the Volume Price Trend (VPT) Indicator?
- Conclusion
Traders and investors use technical analysis to make informed decisions about purchasing and selling financial securities. One of the many technical analysis tools they use is the Volume Price Trend (VPT). It is a comprehensive metric that combines price and volume information to provide insights into the trend direction and magnitude.
In this article, we will explore the VPT indicator in detail, look at the formula used to calculate it and understand how it is interpreted and used in the capital markets.
What is the Volume Price Trend Indicator?
The Volume Price Trend (VPT) is a momentum indicator that establishes a relationship between an asset’s price and volume movements. Also known as the Price Volume Trend (PVT) indicator, VPT is widely used to determine the strength and direction of a particular market trend.
The primary component of the technical indicator is a cumulative volume line, which is calculated by adding or subtracting the percentage change of an asset’s share price from its volume. Traders often use the cumulative volume line along with a signal line to generate trading signals. The signal line is simply a moving average of the cumulative volume line.
With the VPT, traders can gain crucial insights into whether a price trend is supported by strong trading volume or not. For instance, an asset that moves upward with increasing volume suggests a strong bullish trend, whereas an asset that moves upward with declining volume could indicate a weakening trend.
What is the Formula for Calculating the Volume Price Trend Indicator?
Calculating the VPT indicator is relatively straightforward. Here is the mathematical formula you need to use to determine the VPT for an asset.
VPT = Previous VPT + [(Current Closing Price - Previous Closing Price) ÷ Previous Closing Price] x Volume
Here, the previous VPT refers to the Volume Price Trend of the previous period and volume refers to the current period’s trading volume of an asset.
Let us look at a hypothetical example to understand how VPT is calculated. Assume you wish to calculate VPT for a day for a particular stock. The previous closing price is Rs. 2,200 and the current closing price is Rs. 2,250. The total trading volume for the current period is 2 lakhs.
Note: Since this is the first time that you are calculating the VPT for this particular stock, we will assume the previous VPT to be zero.
If you substitute these values in the above-mentioned formula you should be able to calculate the VPT for the stock.
VPT = 4545.45 {0 + [(Rs. 2,250 - Rs. 2,200) ÷ Rs. 2,200] x 2,00,000}
Now, let us assume that you wish to calculate the VPT for the second day as well. The previous closing price would now be Rs. 2,250 and the previous VPT would be 4545.45. Assuming that the current closing price is Rs. 2,280 and the current trading volume is 1.8 lakhs, the VPT of the stock for the second day would be as follows:
VPT2 = 6,945.45 {4545.45 + [(Rs. 2,280 - Rs. 2,250) ÷ Rs. 2,250] x 1,80,000}
For each subsequent day, the VPT value is updated by adding the volume adjusted for the percentage price change. This cumulative approach helps in tracking the trend over time.
How to Interpret the Volume Price Trend (VPT) Indicator?
To gain insights into market behaviour using VPT, you need to compare the direction of the cumulative volume line with the asset’s price movement. Here is how you can interpret the movement of the technical indicator.
Trend Confirmations
If the asset price and the VPT increase, an uptrend is said to be confirmed. Since the trend is supported by strong volume, the price rise will likely continue owing to substantial purchasing activity.
On the other hand, if the asset price and the VPT fall, a downtrend is said to be confirmed. Since the downtrend is supported by strong volume, the price decline will likely continue due to substantial selling activity.
Trend Reversals
If the asset price increases but the VPT indicator is either flat or decreasing, it indicates a price-volume divergence. Such a situation indicates that the uptrend may lose momentum as the volume does not support the price increase. You could view this as a potential warning of an impending bearish trend reversal.
Similarly, suppose the asset price decreases but the VPT indicator is either flat or increasing. In that case, it indicates that the downtrend may lose momentum as the volume does not support the price increase. You could view this as a potential warning of an impending bullish trend reversal.
Trading Signals
You can also use the Volume Price Trend indicator along with a signal line to generate trading signals. To get the signal line, all you need to do is apply a moving average to the cumulative volume line. By comparing the cumulative volume line with the signal line, you can easily determine the ideal entry and exit points.
For example, if the cumulative volume line crosses the signal line and moves above, you could consider entering into a long position in the asset. On the other hand, if the cumulative volume line crosses over the signal line and moves below, you could consider initiating a short position in the asset.
Conclusion
The Volume Price Trend is a tool that can be useful during short-term trading as well as when investing for the long term. By establishing a relationship between the volume and price movements of an asset, the technical indicator can help you confirm trends, identify divergences, anticipate potential reversals and determine the ideal entry and exit points.
That said, it is important to remember that no single technical indicator can accurately forecast price movements every single time. Therefore, it is advisable to use the VPT indicator along with other metrics such as moving averages and the Average Directional Index (ADX). This way, you can increase the accuracy of trading signals significantly.
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