Sunday, September 28, 2008

Money Flow Reversals: One Reason This Market Has Been So Tricky

Readers of this blog know that I keep tabs on an indicator called "money flow", which measures the dollars moving into and out of individual stocks. Each trade is tracked for whether it occurs on an uptick or downtick. If the former, the dollar price of the transaction times the volume is added to a daily cumulative total. If the latter, the dollar price of the transaction times the volume is subtracted from the cumulative total. The final figure at the end of each day reflects the dollar volume (or "money flow") that has moved into the stock (if the total is positive) or out of it (if the total is negative). My research takes the 30 Dow Jones Industrial stocks and calculates the money flow each day for each one and then sums the daily figures to provide a money flow measure for the entire index.

I just took the figures from 2008 and examined all two-day occasions in which net money flows across the thirty Dow stocks were positive (N = 44). Two days later, the Dow Jones Industrial Average (DIA) was down by an average of -.69% (14 up, 30 down). Across all other occasions, the Dow averaged a two-day loss of -.01% (64 up, 74 down).

So far this year, bouts of buying have been met with significant selling in the short term. That has made trading this market quite tricky, particularly if you're trying to identify and follow trends. With Friday's money flow numbers solidly positive, sustained buying on Monday on the heels of any rescue plan news would once again set up a positive two-day money flow period. The market's ability to follow up on any such strength will provide us with useful information about whether bulls find much rescue in the plan.