Speculative Demand Ratio
I have spent a fair bit of time recently thinking about “market moods” and how to best quantify the shifts in the perception of risk by large market players. One productive idea that I have yet to completely test is the “Speculative Demand Ratio” (SDR). Effectively the SDR measures the ratio of money flow into the most volatile stocks versus the least volatile stocks within a given index. For example, the SDR might be calculated as the dollar volume in the top 250 most volatile stocks in the S&P500 divided by the 250 least volatile stocks. Presumably, when the ratio is greater than 1, the demand for risk is greater than average and the market should do well. When the ratio is less than 1, the large investors are getting increasingly cautious and the market is likely to do poorly. In both cases at extremes, the SDR should be a contrarian signal–where ratio well above 1 or well below 1 indicate market tops and bottoms. In either case, the SDR gives a more intuitive gauge of what is going on within the market. While it may be easy with dark pools and other new mechanisms to hide volume and money flow to some extent, it is almost impossible to do so on a large basket of stocks simultaneously. That is why the SDR may be a very useful tool to determine what is truly going on behind the tape.