How Casting Your “Vote” Affects the Market
I talk about volume a lot in this space, as well as in my Trading Trainer community.
The reason is because volume is a critical concept to understand. As I like to say, volume is the great validator.
Stock prices go up and they go down. But every price movement is not the same. The quality of the price movement is determined by volume — how many people were driving the price movement.
Imagine, for a moment, that in one particular stock, there are 100 possible “votes” out there. And let’s say 50 of those votes are typically bearish and the remaining 50 votes are typically bullish.
On any given trading day, there would be an equal push and pull.
But what would happen if some of the people abstained from “voting”?
If 80 of the people withheld their votes for the day — all of the voters that are typically bearish and 30 of the voters that are typically bullish — then that means that 20 people who are typically bullish determine the direction of the market that day.
In this hypothetical scenario, obviously the stock would move in a bullish direction.
However, the bullish price movement would be artificial. Because the next day, should all the “bear voters” decide to vote again… but the 30 voters that typically vote bull abstained again… the price movement that day would more confidently go in the bearish direction — because more voters cast their ballots.
The lesson is this: The number of voters who cast their ballot can be seen in volume. Volume validates price movement.
Without sufficient volume, price movement is less reliable. But the more volume there is, the more confident we can be that the price movement is genuine.
Best regards always,
A.J. Brown
Comments on How Casting Your “Vote” Affects the Market »
You can see this if you plot two stochastic, one price the other volume. Price: plot green((C-L20)/(H20-L20+.001)). Volume: plot red((v-minv20)/(maxv20-minv20+.001)). Note: the +.001 is to prevent divide by zero.
You’ll have four basic patterns;
1. volume high and price low - buy
2. volume high and price high – buy/sell depends on context of trend
3. volume low and price low – buy/sell depends on context of trend
4. volume low and price high - sell
Sometimes this is 100% accurate, once in a row.
I am subscribed to a daily newsletter called “Daily Trader’s Alert”, from Sam Collins and he highlights a remarkable stock for each day. What I like of his graphs is the volume in colors, indicating bulls or bears predominance. Do you think this is a good tool for option
traders? Do you use a similar tool or you use something else in addition?
AJ
I agree with what you said, but percenatage change, can move marketssentiment more than volume, in my experience.
Low volume can actually direct the markets as much or more than average, or high, volume days, simply by market psychology. In fact, it is easier to move markets when as you say, most of the “voters” are not in play. The average trader simply watches the direction of the markets with no consiousness of volume, and “pulls the trigger” in the direction of the market. So, just because volume is low, it can still move markets and have dramatic effects on it. Don’t underestimate moves in percentage, as being just, or more important than volume. This is how the big wigs (hedge funds, institutionals, etc) move markets in the direction they wish. Just get a snowball rolling, and watch what happens. Thanks, Bob R
Hi RichE,
Thank you for publishing your stochastic formulas and analysis routines. Very interesting.
Hi M.Ruiz,
In option trading there is picking a good underlying stock and then there is picking the appropriate options strategy.
It sounds like the report you reference could help with picking an underlying stock. Now, you’ll need to addres the appropriate options strategy.
In my experience, I’ve never had good luck with other people’s picks for underlying stocks. In my experience, I do better when I pick an underlying stock based on what works with my style of trading; the style of trading I can consistently sustain with little effort.
Hope that helps M.Ruiz.
Cheers!
Hi Bob R,
My experience is that low volume high percentage moves are soon reversed. So, I guess it depends on how long you intend to hold your trades. Hours to days… follow the price movements. Days to weeks… look for volume validation to price movements. At least that’s what I’ve encountered.
Thank you for sharing your understanding. It’s good to look at all sides of a topic.
What is considered “high volume?” Low price?
I don’t have any problems with your conclusions about volume but I do question somewhat your analogy. You analogy draws upon the classic notions of the number of buyers versus number of sellers and that relationship to the trend. I have been reading a couple works on chaos theory and the markets. One of the authors proposes that there cannot be more sellers than buyers. The two numbers have to be equal. There may be more potential sellers than buyers but that can’t necessarily move markets as you pointed out if they are on the sidelines. Therefore a better model, as proposed by the author, is that the markets move in the direction of seller/buyer aggressiveness. This fits nicely with your discussion about low volume’s ability to move the market. Using the bid ask spread (aggressiveness) along with volume I believe would provide a better picture of the current market state.
Respectfully
Mike
Hi AJ,
I was looking over some of your other trading “rules” and found your blog from Sept. 2005. Do you still believe this quote which you stated back then, To quote you, “I’m going to recite a quote that I learned from
Robert Kiyosaki a while back. “The bull climbs
up the stairs while the bear jumps out the
window.” What that is referring to is that a bull
market, an appreciating / ascending market
typically gains slowly – it climbs up the stairs if
you will. A bear market, a depreciating /
descending market typically crashes – it jumps
out the window if you will.”
I was looking at a three year chart of the Dow to confirm this sentiment and noticed the rises are just as dramatic and quick as the falls. If you look at the dow bear market from April 07 to July 07 (moved from arond 12 to 14K)the rise is about equal to the fall of our recent bear market from April 08 to July 08 in the amount of around (13 to 11K) Looking at a longer term we had a rise from 7/06 from around 11K to 7/07 of 14K which was one year. Then we had a fall from 7/07 From 14K to 07/08 back to 11K. Both had about the same percentage point moves in the same time period. The only thing I did notice to support your claim, it the bull market seems to be a little bit more consistant, but not by much. Recently we have had equally dramatic swings volotility both in down days and up days, 200 to 300 point moves. Maybe this theory is no longer valid? Maybe bulls now prefer to take the elevator instead of the stairs, While bears still would rather jump out the window, over the stairwell. Thanks, Bob R
Hi Joanna,
I like to trend volume rather than look at absolutes.
I look at:
(1) what is volume today compared to yesterday
(2) what is volume today compared to volume’s 50 day SMA
(3) what is volume today compared to volume’s 200 day SMA
(4) what is volume today compared to the volume oscillator indicator.
Hope that helps.
Hi Mike,
Very cool perspective!
How do market makers play into your theory?
Thank you for adding your insights this blog post.
A.J.
Hi Bob,
I sure do agree that the market has gotten more aggressive recently. You may be right about that rule no longer applying… at least in the specific example you brought up. Although, take a look at a 5 year chart. Sure seems to apply in that case, no?
Perhaps, as more retail (amateur) traders become directly active in trading, reacting mostly to news headlines, the market will become more and more unstable; exponentially so.
The theories, I’m sure are many.
Thanks Bob for adding to the blog.