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Trader's Corner

Volume Indicators as Predictors

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OIN SUBSCRIBER QUESTION:
"...In your weekend article I wasn't familiar with the volume indicator you described...Did what you explained about what this particular indicator tip you to the sell off we're seeing big time this week and explain your suggestion to exit calls?"

RESPONSE:
Today is a good example of what was meant when they used to say, especially about the fast moving futures market, that they (stocks or futures)'slide' (go down) faster than they 'glide' (go up).

When I used to get the Standard & Poor's Trendline charts when I first traded stocks and options in New York, that chart service used to always show (on the cover) a 10-day average of daily total NYSE Advancing Volume. Interestingly, when this 10-day average of volume used to get to certain reoccurring lows and after that, when the 10-day average turned UP, it was often like a 'green light' for the market followed. As the Nasdaq has grown in influence and volume, its 10-day average of total up volume for all stocks in that exchange has become a co-equal vital indicator (1 of 3) for me, especially when Nasdaq is leading the overall market as it has for some months.

There is a Nasdaq Up volume pattern associated with bottoming action and when used in conjunction with some other key index indicators of Price (patterns), Oscillator extremes (e.g., 13-day RSI at or below 30) and bullish or bearish 'Sentiment' readings (the CBOE daily call to put ratio I calculate).

I keep on an open chart both a 10-day average of NYSE total daily Up Volume ($UVOL) that is closely related of course to the S&P and Dow indices and a 10-day average of Nasdaq Up Volume ($UVOLQ) for the Nasdaq. On each chart I also have the two other indicators plotted, that of a 13-day RSI for both COMP and SPX and the ONE Call to Put sentiment indicator I keep, reflecting overall trader sentiment.

In both the S&P and Nasdaq indexes I look for a time when the 10-day Up Volume average drops to and under a particular 'baseline' changing over time but in years not months; then the key is to further wait until the LINE turns UP. If this pattern occurs in a similar time frame, more or less in TANDEM with extremes in two other indicators, that of a 13-day simple RSI and a not so simple 'custom' indicator of mine, the "CPRATIO", this combination of indicators or alignment, has been a magic money maker as a call purchase trigger.

On the buy side, which is the only use of the Up Volume 'indicator', RSI and the CPRATIO were bullish at the July lows but the Nasdaq 10-day Up Volume average (#3) wasn't near the contracted levels which have tended to precede the LONGEST strongest run ups. Sure enough, the rally that followed was a nice trade on the buy side for a limited objective, just not a mega-trade or equal to being in calls during the course of the March-July rally.

A strong buy 'signal' so to speak has tended to occur when all 3 indicators line up at lows. Right now, RSI is falling rapidly and it must, as this indicator is a derivative of price.

However and this should be true of the current cycle, it can take some time for bearish SENTIMENT to build to an extreme; the kind of extreme often occurring before major rallies. This is not the case in the 1.3 reading of today, where total CBOE equities call volume was 1.3 times that of total equities put volume. It will go lower before the next big upside reversal. Market 'sentiment' rarely if ever turns on a dime strictly speaking.

The possible slowness to get traders more scared and bearish than is warranted, ties in with my thoughts expressed this past weekend that a next major low may occur some weeks away such as in bearish Oct; as in many other key bottoms it will be when the bulls see little hope; e.g., the realization that there is still a lot of negative pressures on stock prices, even on tech given a global slowing; U.S. sneezes, world catches a cold.

If I had to present a written checklist for the indicators I've named, PLUS Price action, it would be by the acronym 'POVS', standing for taking time to consider:
Price
Oscillator (the 13-day RSI)
Volume
Sentiment

PRICE action is number one, as apparent in the double bottom low made in March and July. If you disregarded that fact of the double bottom low, and stayed short or long puts, you weren't paying attention to technical considerations for sure.

OSCILLATOR extremes on the low or high side refer to when a Stochastic or RSI indicator of at least 13-days duration is at or below 30 or above 65/70 in the case of the RSI. Oscillators are this type of indicator that fluctuates between 1 and 100.

VOLUME consideration is what I've been explaining, re the importance of certain 'contractions' of Advancing Volume. When that average turns up from oversold levels, the 'weight' of the market has bottomed. A key bottom indicator is reflected in the 10-day average of daily Nasdaq Up Volume in relation to a 'baseline' of reoccurring lows seen in the past 2-3 years typically and as shown on the chart above. Sometimes the Up Volume indicator will bottom ahead or behind the other two; if ahead of it, the saying "volume 'precedes' price" rings true.

The 10-day volume line of Advancing Volume is the best kind of volume info to gauge buying power, as this stat shows traders willingness to pay UP for stocks by buying on upticks. The 10-day moving average of Up Volume, either for NYSE/NASDAQ at baselines and below, then turning up, is useful in sizing up major or intermediate-term bottoms ONLY. (The 10-day average of declining volume turning down from key levels, isn't predictive for tops.)

SENTIMENT extremes or bullish or bearish readings in my CBOE equities options Call to Put ratio; i.e., a daily ratio of CBOE Call to Put volume for equities (excludes index option volume). Extremes around 1 (put volume is at or near total call volume that day) have often suggested turning points in both Nasdaq and the S&P, but the win rate goes very high IF the other indicators have also lined up and 'confirmed' each other in a buy signal.

If one indicator does not line up, especially if it is the Volume or Sentiment reading, it is most often not a major market turning point, although is can be part of a profitable short-term trade trigger.

GOOD TRADING SUCCESS!

Please send any technical and Index-related questions for possible use in my next Trader's Corner article to Click here to email Leigh Stevens support@optioninvestor.com with 'Leigh Stevens' in the Subject line.
 

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