Previously we have shown how volume and volatility are linked. But volatility can go both ways, up or down, so it would be nice to find an indicator which implies a direction as well.
We wanted to look at SPY again because it is an ETF which represents a broad market basket (the S&P 500). In the chart below, the blue bar chart plots SPY’s daily volume on the left y-axis. On the right axis we have plotted SPY’s current price minus its 100 day moving average (in inverse scale). We can see a clear relationship: on high volume days SPY is likely to be trading well below its 100 DMA. On low volume days the reverse is likely to be true:
Thus, trading volume is a great indicator of short term valuation. If volumes are rising, we are likely to be in a period of market weakness. On the other hand, falling volumes entice traders to bet on the long-side. In our view this reflects the bifurcated nature of today’s equity markets: every second we aren’t crashing we are booming.
Categories: Quantitative Trading