VO (Volume Oscillator) is a basic volume based indicator in technical analysis. Such indicators as MVO (MarketVolume Oscillator) and PVO (Percentage Volume Oscillator) are based on the VO and it is essential to understand the physics behind the Volume Oscillator in order to understand the other volume based technical indicators.
The Volume Oscillator formula uses two volume moving averages (VMAs):
Volume Oscillator = [Fast VMA] / [Slow VMA]
Fast VMA is shorter-term VMA
Slow VMA is longer-term VMA
For instance Volume Oscillator (5,25) means that the period of the Fast Volume Moving Average is set to 5 bars (shorter period) and the period of Slow Volume Moving Average is set to 25 bars (longer period).
Basically the Volume Oscillator reveals the difference between two volume moving averages and is used in technical analysis to analyze volume surges (abnormal volume activity). Volume moving average shows average volume over a specified period of bars and applying this understanding to the Volume Oscillator we may say that the Volume Oscillator shows where is the current volume is in relation to the average volume over a longer period of time. Due to the high average volume the good result could be achieved by applying VO to analyze Nasdaq 100, S&P 500, DJI and others indexes with a purpose of trading index derivatives (QQQQ, SPY, DIA and other).
By coming back to our example above of Volume Oscillator (5,25) we have to understand that when Volume Oscillator is above 1 that means that the Fast Volume moving average is above slow moving average. In this case we can make statement that the current average volume over the last 5 bars is higher than the average volume over the last 25 bars, or we may say that we have higher than the normal volume activity (we have volume surge - abnormal volume activity). In other words, the Volume Oscillator gives mathematical evaluation of the volume surge in relation to the average volume over a longer period of time.
Now, when we know the physics behind the Volume Oscillator we can be more confident in using this technical indicator in the analysis. One of the rules of the market "There is no price movement without volume and there is no volume without price move tells us that when we solely rely on the price based technical indicators we see only a half of the picture and only when we analyze volume and price together we may see what is going on behind the scenes.
By joining Volume Oscillator with price technical indicators we may separate volume surges (when VO > 1) during the price move down from volume surges during the price move up. The high Volume Oscillator assumes abnormal volume activity and we may classify the volume surge during the price decline as panic selling and volume surge during the price advance as greedy buying.
