Tuesday, July 17, 2007

Behind the Market's Weak Money Flows

My recent discussion in the Trading Psychology Weblog and my last posting on money flows among the Dow 30 stocks found that the recent rally has differed from previous market strength. The pink line in the chart above represents what I call the Relative Dollar Volume flows for the Dow stocks. This compares the 10-day dollar flow for the 30 stocks to the average dollar flow over the prior 200 trading sessions. When the number is negative, it means that today's flow is below the 200-day average; when it's positive, it means that we have above average flows into stocks.

The chart shows clearly that the recent bull market has been built on the back of above average money flows into the large caps.

During the most recent rise, however, money flows have headed straight south. For nine consecutive trading sessions, we've had below average dollar volume flows. Indeed, we've barely had more money flowing into stocks as flowing out. And that has been during a period of record Dow highs.

Perhaps it is not coincidental that this period of very weak money flows also corresponds to a period of unusually negative NYSE TICK readings. Money flow, after all, is tracking the dollar volume in the market as a function of whether it is occurring at the market bid (selling pressure) or market offer (buying interest). This is the same way that the TICK is calculated, albeit without the volume component.

A number of commentators have suggested that these statistics have become skewed due to the recent abolition of the uptick rule, which had prevented traders from shorting stocks until they traded on an uptick. Without the uptick rule, sellers are free to hit bids just as buyers lift offers. The net effect may be to create a greater (and more accurate) representation of selling pressure, turning the distribution of such measures as TICK and money flow downward.

Still, I'm not convinced that all the weakness in these measures is mere artifact. The fact remains that, as we've moved higher, fewer stocks have been making fresh 20-day highs (my preferred measure of strength) and fewer have been closing above the volatility envelopes surrounding their short-term moving averages (my favorite measure of momentum). Divergences continue to abound among market sectors, as noted in the Weblog.

At an intraday level, as my Twitter comments indicate, I found selling programs greeting the market all day today as we approached Monday highs in the S&P futures. This has continued in spades in after hours trading as I write.

Clearly some of the indicators will need reconfiguration as a result of the change to the uptick rule. One rule that won't be repealed, however, is that rising markets that are losing strength tend to reverse and return toward their longer-term value area (the region in which the greatest amount of volume has been transacted). We saw that dynamic at work during today's trade, and we may be in the process of seeing a longer-term return to value in the extension of the day's weakness.


False Breakout or Fresh Bull Market Leg?


xyz said...

Dr. Brett,

As always you offer the best short term trading content on the web.

I have an unrelated question for which I am hoping you can give me a specific answer.

What kind of annual returns do successful prop traders (stock traders/equity index traders) make on their own accounts? I don't mean the guys at hedge funds or at prop desks at huge banks but rather succesful home traders and traders working at firms like Kingstree.

Thank you.

Brett Steenbarger, Ph.D. said...


Thanks for the kind comment. Your question re: prop traders is tough to answer, because they're not like portfolio managers, who are managing a discrete sum of capital. Rather, prop traders have certain size limitations, risk parameters, etc. and trade within those. That makes it difficult to judge percent returns.

In general, I find that the traders are replicating a relatively small edge with a large capital base. So, for instance, a large prop trader may trade 500 or more ES contracts per trade and might make 50+ trades per day. That's the kind of trader who makes millions.

The successful prop trader who is trading smaller--say 50 contracts--may very well have just as large an edge per trade, but will make six figures per year.

Many independent (home) traders lack the capital base to trade size and can't trade with the same leverage and low commissions as member firms. As a result, they can have the same edge per trade as the hugely profitable prop trader but generally will not make six figures per year.

What I don't see is traders making 50+% per year on their accounts year after year. It may happen, but I haven't found it to be the norm, and I work with some very successful hedge funds and prop firms, including prop desks at banks. It's the smaller, consistent edge with lots of capital that is the more common scenario for success.


Mark said...

Always a source for new ideas to pursue - Thank you!

I'm curious how (which software) you calculate new highs/lows over "n" period. I'm looking to create an intra-day calculation of this and have had no success as of yet.

Any ideas?

Brett Steenbarger, Ph.D. said...

Hi Mark,

I use Excel to calculate new highs/lows; you can also obtain them from the Trade Ideas screening program.