Tuesday, June 30, 2009

Volume, Volatility, and Opportunity: Why Many Traders Struggle

I recently stressed the relationship between volume and volatility as a gauge of trading opportunity within the day. Here we see the principle illustrated at a longer time frame. As volume has steadily come out of the S&P 500 ETF (SPY), we have seen an extended range trade from early May to the present. Note also new lows in the VIX, which is now around 25, considerably down from levels earlier in the year. With reduced institutional participation in the stock market, daily trading ranges have collapsed; the 20-day median daily range in SPY is 1.59%, down from 3.58% at the end of March; 2.13% at the end of April; and 2.00% at the end of May. That is affecting both swing and intraday traders, as moves that once extended now reverse more readily. That is a major reason many active traders are having more P/L problems this year than last.


Matt Fahmie said...

Although I do agree with your inferences about reduction in volume and thus volatility affecting traders p/l if unable to adjust, I would have to disagree with your hypothesis that it has caused range trade. Yes, for the last two months we have seen the market in a longer term balance and the volume and thus the range has been pathetically low. But We have seen this below average volume since the beginning of April, as the market has continued to rally, and make higher highs. The most basic tenant of technical analysis, market profile, and most of your studies are based on the price-volume relationship that suggests a real trend should be confirmed by increased volume in the direction of the trend. Divergence of volume to the dominant trend since the March lows, would originally suggest its validity should have been questioned early. Day to day studies that used show relationships between divergent volume from the overall trend for that day, would suggest possible weakness in the short term. Yet,since the March low we have seen this relationship continually fail, as price continues to move higher on fumes. There might be decreased participation of institutions in respect to the type of volume one would expect from them, but I do not believe they at all have a decreased presence in this market. In fact, I believe they have an increased presence, just in a very different way. Now I cannot show you this currently by comparing relative volume to project institutional participation. Although relative volume is helpful in projecting range potential, on a macro scale, how would you describe the market since the March low? Have institutions not been propping up this market? Seasonality? Possibly. It sure is not the retail trader. Something has been continually propping up this market in a manner that is far different than before. I currently do not have the statistics or data at hand prove this, but call it a Bayesian Inference, it seems fairly obvious. What do you make of this?

Brett Steenbarger, Ph.D. said...

Hi Matt,

What's propped up the market is the absence of selling, not the enhanced presence of buying. The reduced participation has restrained movement; the volume/volatility relationship is statistically significant across multiple time frames.


JimC said...

I'm not sure it's all that complicated.

What you saw at the March low was pricing for Doomsday.

When that failed to occur, we had a long , drawn out, reversion to something more rational.

You see it all the time in individual stocks, rarely with an entire market.

And I have long believed that volume charts give you a much better picture of market action than time charts. Time charts suggest falsely that something should be happening even when volume says NO INTEREST.