Wednesday, April 25, 2018

Why Relative Volume Matters for Your Trading

Above is a two-day chart for Monday and Tuesday's SPY trade.  A number of traders I spoke with missed the market drop, fearful of "chasing" prices when they had been reversing.

The key identification in Tuesday's trade is the rising relative volume to the downside.  Recall that relative volume tracks the volume for each time period (in this chart I'm using five minute periods) and compares it to the average volume for that same time period.  So, for example, a relative volume reading of 0.5 means that we're only doing half the normal volume for that specific time of day.  A reading of 2.0 means that we're doing twice the normal volume.

Notice how, as Tuesday moved forward, relative volume expanded well above 1.0, particularly on market selling.  This started to occur well before we saw the waterfall decline in the afternoon.  The increased relative volume told us that participation was increasing to the downside.  This participation represents directional participants who move size and thus can lead to momentum and trending moves in the market.

The steadily rising relative volume tells us that we're picking up participation as we're going lower.  Selling is by no means drying up.  That is a market where you can afford to "chase" prices lower.

Simple tools like relative volume are very helpful for identifying opportunity in the market.  If volume is shrinking, it's unlikely that moves will extend.  Breakouts from ranges with increasing relative volume suggest that traders are indeed accepting new levels of value.

Who is in the market is a key ingredient in how you should trade.

Further Reading: