How to Use Big Volume to Predict the Price Direction

I have been keen to do an interview with Mike DiBari for a while now. He has a fascinating way of understanding the markets that I have never heard about anyone using before. Mike has developed his own technical indicators that are based purely on market volume. Mike uses his Total Volume Oscillator (TVO) as part of a trading strategy. He is a technical trader that does not use price as part of his trading decisions.

I find this approach fascinating and if you are intrigued by Mike’s system, he posts daily updates of the indicator level on his blog: Trading Licks, and also on Stocktwits and Twitter. These updates include Mike’s insightful comment on the state of the market based on the volume. What I like about these comments is the way that he disregards any hysteria about price rises or falls and focuses on his reading of the volume.

I first spoke with Mike when he contacted me with some questions about using Tradinformed backtest spreadsheets. I am absolutely delighted that Mike has been able to test his market theories using this method and has developed such a great trading system.


Can you tell me about what first interested you about the financial markets?

I was enticed by the stock market originally through the lens of many Hollywood films like Wall Street and Quicksilver, where ordinary people seem to strike it rich so quickly and easily. I always thought I’d like to be able to do that, but then I found out that things don’t always work out so easily in reality. What may have discouraged me at first was my friends and family saying that stocks were too risky. There was always some story about some relative or friend of the family that lost a bundle, so I stayed away. When I finally got around to investing, I decided to “play it safe” at first and looked into mutual funds. That was back in ’07 and I had just read a book on how you can’t lose with investing in a small variety of index funds. Luckily, I procrastinated just long enough to avoid losing what could have been almost half of my money. After the financial crisis, I became fascinated with the idea of using technical analysis to trade stocks and ETFs. I read almost every book out there on the subject including my favorite, “How I Made $2,000,000 in the Stock Market” by Nicolas Darvas, and since then I’ve been continually striving to find my own better method for trading.

Could you tell me about an early trade (either good or bad) that has influenced the way you think about trading the markets?

I found a nice setup for a company called Shutterfly, which was an IPO at the time. I took a chance and went in right before their first earnings report, a risky position to say the least. I remember thinking, oh it’ll be just fine, it’s a great company… It can’t possibly go down. I had no idea at the time about the volatility of IPOs, especially around earnings. The next day the stock rose almost 10% and I decided to sell, but I missed a good portion of the gains into the close. I did come out of the experience with bragging rights, though, which I’ve learned can be a dangerous thing. The new found confidence gave me the sense that I could somehow keep picking winners again and again, so I tried a few more pre-earnings plays and needless to say they didn’t all turn out so well. I learned that feeling good about a company or a trade may or may not have any bearing on the outcome because you never know how the market will react to reports and news. Sometimes the cause of a stock’s rise or fall has no correlation to the event even though we often think it does, so skill can be mistaken for what’s really blind luck when trading.

What markets are you interested in and like to follow? Also what markets do you particularly like to trade? Why do you follow these markets in particular?

The NASDAQ and the S&P 500 tell you just about everything you need to know about the state of the market. I do take the Russell and the Dow into account, but only in a footnote kind of way. For trading, I originally started out with sector ETFs as an alternative to stocks as they’re less volatile and you don’t have worry about individual companies financial data. The problem is that there are so many different ETFs representing every type of market and sector, that you still have to spend way too much time and effort to find the ones with the most “relative strength” and so on. I eventually settled on trading just the S&P (SPY), mostly because all the best companies are already represented and the backtesting results blow away all the other ETFs as far as consistent performance over time. I also like that SPY monthly options are highly liquid and the bid/ask spreads are within reason.

I read your Trading Licks blog updates every day. I love the way you put a lot of color into your daily posts. It really helps to bring the market moves alive. What have you enjoyed the most about writing a daily market blog post? Have there been any surprises?

Thank you for reading Mark! I’ve read so many financial blogs where the content was interesting, but the text was so long winded and the language far too technical. I set out to do just the opposite, so I respect the reader’s time and try keep it short and get to the point as soon as possible. At the same time, I enjoy making the content more interesting with as many colorful metaphors, pop culture references, etc., as I can come up with because those are things I think most folks can relate to and can help drive the point home much more effectively than cumbersome graphs and statistics. My hope is that you’ll learn something new about the market and think about at it in a way you may not have before. I really enjoy writing about market volume because you never know exactly how it’s going to turn out until after you do the numbers. I’ll look at a candlestick chart and expect strong volume to accompany big price moves, but it’s often the opposite of what you’d expect. I never underestimate the importance of volume and the effect it has. Price action alone can often fool you, where volume just tells it like it is.

Do you think writing the blog has helped your own trading?

Yes, without a doubt. The message in the data becomes so much clearer when you set out to explain it through writing. Constructing the blog helps me to filter out the excess noise and stick to my own methodology. Tuning out noise and opinions from other traders and the media is one of the single most difficult things to do. I’ve read so many posts from other traders who lost their focus, which ultimately led to their downfall.

I get the impression from some of your blog posts that you view some market moves as a bit of a game. Do you agree with this?

I’ve seen the same moves and stories so many times over and over again, that it really does feel like there’s a select few running the show and we’re all just along for the ride. My real analysis, though, is that it’s all random and we as humans see patterns and cycles because that’s what we’re hard wired to see. Once you start looking at things that way you can’t help but feel that all the ups and downs are just a game, but despite the randomness and all the forces that are against you, I believe it is a winnable one if you have a well defined strategy.

You often refer to fundamental factors in your blog. Do you include these factors in your trading or are they just for your own interest?

As much as I think that fundamentals are important, they really have no direct bearing on my trading methods. I do think it’s good to mention and be aware of things like Fed meetings, economic reports, etc., to help get the big picture and tone of the overall market. The news media does work hard to make you believe that the market hinges on these things, so I feel it’s helpful to highlight whenever I can that this just isn’t always so. In the case of volume, though, all the fundamental market factors are mostly already rolled into it, so in using a volume based system, I am in effect trading indirectly off these factors without necessarily being aware of them.

You have developed your own indicator – The Total Volume Oscillator. I like the idea of using volume in trading decisions. Can you tell me why you decided to develop your own indicator? Did you have a specific goal in mind when you started the process?

I started keeping a log of daily end-of-day volume data at first just to keep an eye on general market conditions. Then I started to notice that certain volume activity often preceded major moves and that the price indicators I was using at the time lagged significantly or told another story altogether. That’s when I started thinking what if I could quantify the volume data so it could be used by itself in a trading strategy, and that’s what led to the Total Volume Oscillator or TVO. You often hear how prices in the market are manipulated and or exaggerated. I became so frustrated as to what to believe, so I set out to see if it was possible to trade with just volume alone. The results were astonishingly better than I expected, and I’m continuing to find new ways to calculate the data in even more effective ways like the new Heat Gauge I recently developed.

Isn’t it crazy to think you can trade the markets just by looking at volume? What drove you to think that you could get a good strategy just by looking at volume and excluding price?

Well, that’s a good question, I think I am little bit crazy! I feel that those are things that I look for. I look for the angle that hasn’t been explored too much. When you look back historically at a lot of traders and some of the books I have read. A lot of them got their fortunes from doing things that were not accepted or that other people thought were crazy. You read about Jesse Livermore or even Paul Tudor Jones. There are always talking about those kind of things, and everyone thought that will never happen.

Once you had made the decision to create TVO, how did you go about the process of developing, refining and calibrating it?

I knew that in order to develop a profitable system, backtesting would be a key element. Even if you observe the data in action, as I did for several years, that’s simply not enough of a time period for trustworthy results. Also, because I was designing a volume based system, the majority of backtesting software out there (most of which is based on price history) was useless for the volume history I was trying to test. I had the data already compiled in spreadsheets, but I needed to improve my Excel skills, so I started searching online for ways to do that. Luckily, I discovered some of your videos, Mark, on YouTube which led me to and your first book, which turned everything turned around for me. I know that a lot of traders relate well to indicators and oscillators, so I was able to come up with an algorithm that generated a consistent number value in an oscillator format. The positive and negative values reflect the volume behavior of big institutional buying and selling and helps to track accumulation and distribution in the market.

I have heard volume described as the “truth teller”. What do you think about this? Do you consider it more important than price when analysing a trade?

Our perception of price can be influenced in so many ways by so many different factors, but volume basically is what it is. Where there’s volume there’s interest, and you can almost always see that happening in the data before the move occurs. I’ve found that being in touch with the volume of the market keeps you ahead of the curve. There have been many times that I’ve seen things in volume that didn’t get reflected in price until much later. Sometimes when prices are sky high and everyone is screaming overbought, the volume tells another story that things can indeed go higher. Another aspect of what I like about trading off end of day volume data is the time it’s given me to focus on other things in my life. I do the numbers and the blog at night, which works for my schedule, and since my trade entries are mostly market on close, I don’t have to look at the screen throughout the day. Some of the price systems I’ve used in the past did work very well, but the trading required much more daily vigilance.

How important do you think backtesting is in developing a trading strategy?

I’ve heard some people say that you have to backtest. And I’ve heard other people say that it’s useless. Backtesting is not accurate, don’t worry about it. But when I found your stuff it totally opened my eyes. I thought, this is it, this is what you have to do to get a strategy. Because there is really no other way to get an edge, other than to backtest. It may not be perfect, the past does not necessarily repeat. But I don’t think you can do much better.

Backtesting is the only way that you can find out if your theories have any merit, otherwise you’re pretty much flying blind. I know, because that’s what I did in the beginning and my results were scattered at best. The problem is that you could be trading blindly and have several winners in a row and think that you’re on to something, when it’s really just a chance winning streak. You could also have several losers in a row and start to think you need to revamp your strategy, or you might just feel like giving up altogether. A solid backtested strategy helps to avoid the human emotions that can interfere with crucial trading decisions. Also, you may test a strategy that has a high win rate, but doesn’t produce a very high rate of a return over time. The historical perspective of years of trades helps to reveal those kind things that you just can’t recognize in the short-term.

Do you have any suggestions or advice from lessons you have learned when backtesting?

Yes, don’t over test! It’s a natural inclination to tweak at something until you get the best results. Your system may look perfect after intense curve fitting, but it may end up way too complicated to practically put to use. Reality always turns out very different than models. It’s also tempting to try to fine tune your backtesting results after you’ve had a series of real world losers. That can be a costly mistake because every system will inevitably have drawdown. It looks fine on paper, but when it happens, you’ve got to be ready to stomach that. I use to follow my gut before I learned how to backtest and ended up sick to my stomach way too often.

What about forward testing? Do you tend to refine your trading strategies going forward?

There are effective ways of doing that including a spreadsheet I designed as a Monte Carlo simulator which can give a good idea if a strategy is profitable through the results of 500 or so simulated trades. The problem with that, though, is that all of those results exist in a vacuum, so to speak, without any of the real influences the market experiences, so it’s really best as just a guide to help you stay on the right track. No matter how great your stats look, there’s always going to be the occasional anomaly of something that “happens only once in X amount of years” and so on, and the best you can do is trust your thesis and weather the storm. It actually isn’t much different than predicting the weather in my opinion. The models can do a pretty good job of forecasting, but sometimes it just doesn’t rain for a while.

I notice you use options in your trading? Why do you use options rather than ETFs, futures or any other way of taking the trade?

I did trade ETFs for a while but there is something about options that appeals to me. I like the leverage and how they are structured. At first it was confusing, like a lot of people just trying to understand how they work. But once I got the basic idea I thought it made more sense. Also, I use less of my capital. If I was trading the SPY with an ETF I would have to put everything into it to get the same results. So I can use other systems and well, I don’t have to trade just one system.

What advice would you give someone about trading?

I’d say find as many books, websites, videos, etc., as you can, soak it all in, and then put that all aside and come up with your own method. You could try to copy the most successful traders out there, but if their plan doesn’t gel with your personality you’ll be quite frustrated. I always fantasized at how cool it would be to be a day trader, until I found that the lifestyle of staring at screens all day was not really for me. You’ve got to become familiar with all the styles first, then hone in on what works for you and build your strategy from there. Try to spend as much time as you can learning about general psychology too, because after all, the markets are traded be people, and if you can understand basic concepts of human behavior you’ll be one step ahead of the crowd. Another thing is it’s okay not to trade. Trust your system and let the trades come to you. Use the time you’re in cash for backtesting, designing new methods, or simply take time off and enjoy life!

What is your opinion about the current state of the financial markets? How do you think they might change in the future and how do you think traders should prepare for it?

I saw a clip from the 1950s or 60s which featured someone rambling on about the debt ceiling crisis and how it spelled doom for the economy. The language may have evolved somewhat, but it’s the same old rhetoric time and time again. It’s been a rough road, but we’ve learned that markets are resilient because human nature never changes. There will always be a Greece or some kind of crisis looming that many will say is threatening to take everything down, but we all strive to make ourselves better, so in the end markets keep coming back stronger than ever. I remember Warren Buffet saying in ’09 that stocks were a bargain, but a lot of folks, including myself at the time, had some serious doubts about going all in. There are systems that I’ve backtested that showed a profit in ’08 when the market was going down in flames, but I’m guessing that most traders would have found it difficult to tune out all that noise and trade the signals. The best state you can be in for trading is where you have enough confidence in your method to execute your plan, even when the rest of the world is running for the hills and calling you crazy. Start practicing and developing your strategies while the waters are calm, so when the next big opportunity comes along you’ll be ready for it.

What did I get out of speaking with Mike

Be creative in looking for the angle that has not been explored. I like the way Mike has used a little explored part of the markets for his trading system. Most technical traders totally ignore volume whereas Mike made it the central part of his strategy.

Explore other ways of structuring a trade. Mike makes his trades by buying options. The potential risk is fixed whereas the potential reward is unlimited. You can trade on margin and take advantage of big volatile moves in favor of your trade. However, options trading is more slightly more complicated because the trader must decide about the strike price and the expiry date.

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