Use Raindrops to Supercharge Your Favorite Indicators Through Native Volume-Weighting
Raindrop Charts are a new type of financial chart that leverages volume data to render visualizations that demonstrate not just where price moved, but how volume was distributed along with this move. In order to facilitate this type of chart, arbitrary breakpoints such as open and close prices must be eliminated in favor of volume-weighted average prices (VWAP). Each Raindrop consists of two sides, and each side represents one-half of the trading period. The bar dashes on either side represent the VWAP for that half of the trading period.
Most charting platforms allow you to change the indicator inputs used to draw your favorite indicators. You may choose to use the high price instead of the close price when drawing a simple moving average, for example. However, no platform allows you to volume weight the input – until now. Volume is a core component in price chart analysis and should not be ignored – but often is simply because incorporating it into analysis is difficult.
By now, you have probably seen this image:
When a Raindrop is rendered on the chart, the open price becomes the left VWAP, and the close price becomes the right VWAP. Since indicators are drawn from the open and close prices, and they are now replaced, the indicators are now drawn from volume-weighted points instead of arbitrary ones.
This creates a subtle but meaningful change in various indicators. A simple moving average now becomes a volume-weighted simple moving average, which is very similar to a VWAP line. An EMA, or exponential moving average, also becomes volume-weighted. As do lower indicators such as RSI, which is typically drawn using the right or close price, MACD, Stochastic RSI, Williams %R, and many, many others.
This subtle difference is visible by measuring the various points where a simple or exponential moving average is on a chart at a specific point in time. In this example, we compare the Raindrop Chart version of AAPL, D to the traditional Japanese candlestick version of the same chart. You can see that the various upper indicators are all impacted by the volume weighting effect of being drawn using Raindrops instead of candlesticks. This is visible by looking at the Bollinger Bands(r) as well as the EMAs printed below:
This effect is also visible on lower indicators, as previously mentioned. You can see the impact on two such lower indicators below. Notice the subtle differences in waveform in both the RSI and MACD and the correlation of these points with the Raindrop patterns illustrated above them, specifically the Blue Doji Raindrops.
While subtle in these examples, these differences can be more pronounced in more volatile, less liquid securities.
This type of native volume weighting has several advantages, in our opinion.
- A more honest representation of price action leads to a more honest representation of indicator signals
- Price movements on high volume are more significant than price movements on low volume, but traditional indicators and Japanese candles do not contemplate volume changes – only price changes
- Indicators with volume weighting may lead indicators that are not volume-weighted and as a result may provide earlier and more reliable signals
These, and other reasons, warrant further research into which inputs are best for drawing indicators.