Wednesday, May 02, 2007

Daytrading Stocks With Money Flow Patterns

Recall that the relative money flow indicator is designed to track the buying and selling preferences of large market participants. Each trade in a stock is tracked by multiplying the volume of the trade times the trade price. That gives you dollar volume. If that trade occurred on an uptick, the dollar volume is added to a cumulative total. If the trade occurred on a downtick, the dollar volume is subtracted from the total. The running total, called money flow, is very sensitive to large trades occurring at the market offer price (aggressive buyers) and at the market bid (aggressive sellers).

In my relative money flow calculations, I simply express money flow as a proportion of total volume. Thus, if volume expands from period one to period two but money flow remains the same, we can see that the market is losing efficiency: it's taking more volume to create the same inflows.

Until now, all my money flow research has used end-of-day data. Here we see a chart of Citigroup stock (C) for 4/30/07, with 15-minute bars. Above the opening bars, we can see the relative dollar volume flows specific to those 15-minute periods. Let's walk through the early morning trade:

The Dow opened lower that morning, but C opened higher on positive money flow. In fact, 15 of the 30 Dow stocks traded with outright negative money flows during the first 15 minutes of the session. That C opened higher with positive flow was our first sign of relative strength.

Note what happened in the second 15-minute period. Not only did C jump higher in price; the relative flow for that period was a whopping 12.74. (As a point of reference, consider that the median relative flow for C from 2004 to the present has been 3.46). This means that large trades were very aggressive on the buy side, even though the market overall was not strong.

In the third 15-minute period of the session, volume in C jumped meaningfully, but relative flows rose even more to an eye-popping 20.06. That means that institutions are jumping into the stock (rising volume), and their participation is strongly bullish. They are willing to lift the offer price in order to get into the stock.

Notice how this bullish momentum then carried us higher over the next hour on solid dollar volume flow readings. The active trader, noting the relative strength in the stock and the very strong money flows, had plenty of opportunity to participate to the upside.

(Note: Relative flows began to wane after this period and actually turned negative during the afternoon, with the final daily reading coming in at 2.83. In a future post, I will examine reversal patterns in the money flow data).

When a stock opens higher in a down market on solid volume and with positive money flows, that should trigger an alert for the short-term trader. Large market participants are so interested in owning this stock that they're bucking the overall market. Once we then see *rising* relative flows and rising volume in the stock, we know that there is significant demand for the issue. That is the kind of scenario that lends itself to short-term trending moves.

It's a promising example of how traders can track the behavior of the market's largest participants by focusing on the opening minutes and finding a potential directional edge. More from this research to come.