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Speculative Demand Ratio

July 12, 2010

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.

3 Comments leave one →
  1. bgpl permalink
    July 12, 2010 12:56 pm

    wouldn’t this need to be normalized somehow ? i.,e if the least volatile stocks are also the highest market cap stocks, they would dominate the dollar volume, and the proposed ratio would skew towards less than 1 for the most part.

  2. david varadi permalink*
    July 12, 2010 1:00 pm

    hi bgpl,indeed we have adjusted for that—but good point nonetheless. the way to do this is to use the change in average daily dollar volume.

    best
    dv

  3. bgpl permalink
    July 12, 2010 2:07 pm

    hi David,
    thanks !
    Would that be a normalized change in average daily dollar volume ?
    i.,e
    a> (change in average daily dollar volume) divided by (average daily dollar volume) ?
    or
    b> the change in average daily dollar volume ?
    If the latter (b), then is it possible that this is also skewed in the sense that large cap stocks are likely to have larger first derivatives of volume in absolute numbers ? for example, a GE or XOM is likely to have a larger change in daily dollar volume than the 500th stock in the S&P anyway, and thus skews the result towards GE – (which may be fine: i just want to understand)
    If the former, i dont know how this is related to actual dollar volume flow as it is a normalized average ?

    or may be both to give a feel for both factors, much like the unweighted price index serves its purpose..

    sorry for the peskiness: the background of this is that inspired by one of your earlier posts on market dynamics where you mention taking the DV2 of the top 50 stocks in nasdaq100, i tried the above with volume, and some of these questions came to mind during that process.

    best wishes,
    bgpl

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