What does volume have to do with value?

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:
volume_barsThus, 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.

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