Monday, June 11, 2007

What's Behind The Bull Market: Breakout in Money Flows

Suppose we have an indicator that keeps a running total of every trade made in a stock. It multiplies the price of the stock times the volume of the trade to provide an indication of the dollars that go into the trade. If the trade occurs on an uptick, it is added to a daily cumulative total; if it occurs on a downtick, it is subtracted from the total. The resulting measure at the end of the day is a measure of money flow: the dollar volume that enters or leaves the market.

Above, I have gone back to 2005, calculated the daily dollar volume for the 30 Dow stocks, and summed them to provide a picture of the dollars entering and leaving the Dow Jones Industrial Average. The chart shows a five-day moving average of the Dow's dollar volume (pink line) vs. the Dow average itself (DIA; blue line).

We can see that dollar flows have pulled back of late in the Dow stocks on the heels of rising interest rates. Still, those flows remain net positive. Similar pullbacks of late have represented good buying opportunities.

More important, we can see that a major shift in investors' allocations occurred following the June/July, 2006 lows. There was a surge in dollar volume, suggesting that much more money was being put to work in the stock market. After the late February/early March pause, that surge continued. This shift in allocations is what bull markets are made of. In my latest update to the Trading Psychology Weblog, I chart the money flows specific to eight S&P 500 sectors. This shows us that, while flows have slowed, they remain at positive levels--and in some cases remain above their long-term averages, even after the market weakness of last week.

The chart above shows us that money flows into stocks broke out from a long-term range. That has created a sustainable rally. Do such money flow breakouts occur in individual stocks, and might that become a basis for stock picking? More to come on this promising measure.


Tracking the Dollar Volume Flows of Stocks

Dow Returns Following Extreme Money Flow Days