1) Who is in the market?
2) Are they becoming more active in the market over time?
3) Are they able to move the market directionally?
Above we see a chart of yesterday's price action in SPY (blue line), plotted against five-minute readings of relative volume (red line). (Raw data from e-Signal; all calculations in Excel). The relative volume is expressed in standard deviation terms. Each five minute period's volume is expressed relative to the median five-minute volume and standard deviation for that same time period over the past two months. So, for example, a reading of zero at 10:05 AM (all Eastern time) would mean that we traded exactly at the median volume for the 10:05 - 10:10 period. A reading of 1.0 would mean that we traded at one full standard deviation above the median volume for that period.
What we're looking for relative to the three questions above are:
1) Do we see significantly above average participation in the market? If so, we have a good indication that speculative players in the market are active. If not, we could have a slow market dominated by market makers.
2) Do we see participation increasing over time? We want to know if those speculative players are being drawn to the price action or whether the market's auction is shutting down as prices move from value.
3) Do we see evidence of trending behavior corresponding to the participation in the market? Are we getting two-sided action--action where both buyers and sellers are aggressive and keeping the market in a range--or do we see a dominance of buyers or sellers over their counterparts facilitating a market move away from value?
Yesterday was a Fed day and we also had an important GDP number early in the morning. As a result, we saw above average participation in the market early in the trading session. Relative volume picked up with morning market weakness and dried up ahead of the Fed announcement at 14:00. At that point relative volume spiked with the appearance of buyers. Nothing in the Fed's announcement--and certainly nothing in the weak GDP report--led participants to think that monetary conditions would be altered in a way that would be harmful to stocks.
Yet what do we see for the remainder of the afternoon? Apropos to points 2) and 3) above, relative volume tailed off steadily and price could not break above its early morning levels. In other words, on a relative basis buying interest was drying up and there was no reason to move price above where value had been established on the day time frame.
What does that suggest? Nothing in the Fed action was perceived as a meaningful game changer for stocks. The interplay of volume, price, and time help us understand the demand and supply behind the market's action. That provides us with meaningful reference points for the following day, as it will take fresh volume flows to move us out of yesterday's range.
Further Reading: Relative Volume and Market Opportunity
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