Saturday, September 03, 2016

Tracking Buying and Selling Flows in the Market

The above depicts trading in SPY during New York hours  on 9/1/16.  SPY is plotted in blue.  The red line represents 1-minute closing values for the US TICK, which captures net upticks versus downticks for all listed stocks.  When buyers are dominant across all stocks, we see net upticking.  When sellers dominate, we see net downticking.  Readings near zero represent a relative balance among buyers and sellers.

As the day moves forward, we can ask meaningful questions:

*  Is there a significant amount of buying or selling coming into the market?
*  Is the relative distribution between buyers and sellers shifting in a particular direction?
*  Is the buying or selling activity able to meaningfully move prices in the index?
*  Cumulatively, over time, is the market trending toward buying or selling or is there relative balance?

As you can see, as the day unfolds, we can update our views and identify patterns as they emerge.

If we add to US TICK an overlay of other measures, we can ask further questions:

*  Is the buying/selling in stocks benefiting some sectors more than others?
*  Is the buying/selling for large cap stocks (DJ TICK) confirmed by broader buying/selling across stocks?
*  Is the buying/selling in stocks accompanied by significant expansion of volume?
*  At which price levels does buying/selling and volume expand vs. dry up?
*  Does a news item or data release lead to a significant shift in volume and buying/selling?
*  Can we aggregate these shorter-term measures to crystallize a longer-term market view?

Notice the psychological and cognitive qualities needed to trade this kind of information:

Open-mindedness, to let market patterns unfold in their own time and in their own way;
Flexibility, to update market views as flows shift;
Quick processing, to see patterns unfold on short time frames;
Tolerance for ambiguity, to hang in when patterns are unclear or in transition;
Parallel processing, to see patterns unfold across multiple market measures;
Decisiveness, to act on short-term patterns at good price levels
Creativity, to see new patterns among different data
Persistence, to collect and study the above data over a period of years

At the end of the day, the market is an auction process.  The best short-term trading exploits information that captures the ongoing activity of buyers and sellers, leveraging our psychological and cognitive strengths.  Many trading failures occur, not because of a lack of those strengths, but because traders are processing the wrong information, blinding themselves to what is happening at the auction.

Further Reading:  The Three Most Important Questions Facing Traders