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Adjusting to Current Market Conditions: The Increasing Importance of SPY Volume

March 4, 2010

I thought it would be useful to point out what is working well in today’s market- in this case over the last 3 months. Below I present a quick and dirty analysis- not as thorough as I would prefer, but enough to highlight some useful data that you can further explore. One of the interesting factors that has become quite predictive in todays market–at least in predicting the S&P500– is SPY volume. More specifically, the 5-day ROC  or 5-day simple moving average of SPY volume has performed quite admirably as a market timing indicator. I suppose all of us can listen to the  “experts” yap away whether bullish or bearish on CNBC , but ultimately the best way to see what their intentions are these days is to look at their cards so to speak. It isn’t Mom and Pop that are responsible for increasing volume when SPY trades roughly $25 billion dollars a day. No, its the big money responsible for doing that–whether its the US government, the banks, or mutual funds–it really doesn’t matter. Whenever they buy these days, they are signalling the intention of buying over a series of days. Whenever the buying momentum starts to fall, the market loses traction. Lets look at the stats over the last 60 trading days. Note 5dROC SPY volume stands for the 5-day rate of change of SPY volume–for example a positive number indicates that SPY volume is higher than 5 trading days ago. “C” stands for today’s close, and C(-1) stands for yesterday’s close. “V” stands for today’s SPY volume and V(-1) stands for yesterday’s SPY volume:

  avg daily    
  ret. win% #trades
5dROC SPY volume >0 0.29% 75.00%    28
5dROC SPY volume >0, C<C(-1) 0.48% 86.67%    15
5dROC SPY volume >0, C>C(-1) 0.07% 61.54%    13
5dROC SPY volume >0, V<V(-1) 0.62% 87.50%      8
5dROC SPY volume >0, V>V(-1) 0.16% 70.00%    20
5dROC SPYvolume <0,V<V(-1) -0.22% 47.62%     21
5dROC SPY volume <0, V>V(-1) -0.08% 63.64%     11
5dROC SPY volume <0 -0.17% 53.13%     32
5dROC SPY volume <0, C<C(-1) -0.58% 37.50%       8
5dROC SPY volume <0, C>C(-1) -0.04% 58.33%     24

These days the most bullish configurations involve rising volume momentum, while the most bearish involve falling volume momentum. Specifically of note are what some technical analysts sometimes refer to as “accumulation days” when the market is strong, but the market falls today on rising volume (although there are so many widespread opinions on volume it is better to look at results). In this particular setup, the market has risen an incredible 87% of the time with an average daily return of .5% over the last 3 months–although this has only occured 15 times. Another highly bullish configuration has been when the 5-day ROC of SPY volume was higher, but today volume was lower than yesterday– this led to nearly 88% winners with an even higher gain per trade of .62%. Screening for all three (higher 5-day ROC SPY volume, lower volume today and a lower close)  produced far too few instances to draw conclusions but they were both winners with an average gain of 1.41%. The most bearish configuration has been when 5-day ROC of SPY volume has fallen, and today’s close has also fallen–only 8 occurences but in this bull market this situation has led to only 37.5% winners and a negative  average daily return of -.58%. Another more common situation worth considering is when both volume measures have fallen- both the 5-day, and today’s volume versus yesterday. This happened 21 times in the last 60 days, and only 48% were winners with the market losing -.22% in these instances.

So what should we take from this? Markets are always changing, and there tends to be predictable momentum in market behavior over time. What is working over the last 3 months is generally a little early to draw strong conclusions, but it is at the point of becoming relevant especially when looking at next day returns that have more degrees of freedom versus longer-term strategies. In this case you  might want to consider the impact volume in the current market to help time trades–even if you are not trading the SPY. In a market that has shown tremendous bullish momentum, and has proven really tricky, this is one indicator that has provided some clarity–amazingly it has been able to predict when the market is likely to fall. Certainly, it has been a strong predictor of when it will rise.

2 Comments leave one →
  1. Jake Jeppesen permalink
    March 4, 2010 8:24 am

    Please clarify how you are calculating 5dROC.

    Thanks for your good work!

  2. Kevin permalink
    March 4, 2010 9:23 am

    David – would I be correct in assuming that execution of this next day strategy would require either 1) anticipating today’s closing price or volume and trading just prior to close or 2) trading at the next day’s open? Nice work as usual.


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