Month High Volume Revisited

Is it volume which causes price changes, or do price changes cause volume –the hen or the egg, which came first? -H.M. Gartley, Profits in the Stock Market

To use a homely analogy, volume is to the price movement of stocks as gasoline is to the automobile. If you step on the accelerator of your car, giving the motor more gas, the car will start to travel faster. The more gas you feed it, the greater will be its momentum. Now, when your car has acquired considerable momentum, if you throw the clutch out and coast, your car will travel a considerable distance on the acquired momentum. -Richard D. Wyckoff

The current consensus is that high frequency trading accounts for 70% of the daily market volume on the surface and below the surface it is estimated that dark pools accounted for 32% of the trades in 2012 and this has most likely increased in 2013. As retail traders it is important to understand the implications of this, particularly in smaller caps and stocks that trade a few hundred thousand shares a day and assess who is on the other side of our trades and how this effects our price potential. If there is an average of 200K shares traded and 70% of that is HFT, this leaves a pool of 60K shares for day, swing, and positions traders, both professional and retail.

There are both positives and negatives to this. One major positive is that when these algos run amok and in our direction they can rapidly push price in our favor. This works best if one is already positioned in the stock. A counter point negative is that on entry day this can cause price to move beyond a proper risk/reward price point and also has the effect of deeper sell offs into the close or lack of follow through the next day because the demand is mostly manufactured and the absorption of supply is temporal and mainly intraday. Another negative is that the supply remaining can be easily moved by a small group of day traders taking a position then blasting it out to their 10,000 twitter followers.

We can bemoan this effect or we can realize from historical study that there always has been and always will be disadvantages presented to the average retail trader along with the standard risk of trading that applies if the game were fair. Although this is the case, the underlying fundamentals of market mechanics remain the same to this day and the same edges, anomalies, and patterns of 100 years ago work today. One significant change that has occurred, however, is the underlying internal market structure. Darvas spoke of abnormal weekly volume when shares traded exceeded 50 thousand, but the market has become much larger and the vast majority of the stocks in my universe trade more than this on a daily basis. Another fundamental shift is that during Darvas' time the majority of trades were transparent and there was not an informational edge when it came to price/volume relationships, unlike today where the order flow is algo driven or often hidden resulting in a lack of complete information and therefor a disconnect between price/volume.

When I started my studies of volume a year ago I was well aware of the perspective that “Only price pays.” and that volume was not particularly relevant or useful any more due to distortions and off market exchanges taking place. Hell, I even had a hard to reconciling the value of volume and its importance to myself. But, what is often left unreflected is that while price may pay what is the price being paid in the first place and is it an honest price, for not only does a significant amount of volume go unregistered, the prices being paid does as well. And even though I was aware of the statistics and effect of HFT and dark pools I continued to move forward with my line of thinking because volume has to matter after all because along with the open, high, low, close, it is the only other piece of information available.

As a result of these studies and realization of the effect of HFT and DP I've made the decision to move up to higher time frames, particularly the monthly when it comes to my volume studies. I started doing this 6 months ago and now have a model book of the best performing stocks during this time based upon this metric and have been able to improve my criteria for vehicle selection based upon the greater clarity this time frame gives when it comes to quantifying the absorption of supply. Once strong hands accumulate the float the expectation is that the clutch can be thrown into neutral and price will continue its acceleration as the shares that remain come at a premium.

March Momentum/MHV Watch List: 19% of list increased 50%+

Another change I've made to my trading over the past year is to my entry and time stop. Unless there is a compelling reason to enter a trade off the open I will wait until the last hour before making my decisions. There is a trade off as mentioned previously in which I will forgo some of the algo driven potential, however I also get to see if my signal completely forms and price is not faded and sold off hard into the bell. A second modification I made is extending my holding period from 3-5 days to 10 days to account for the lack of immediate follow through I've witnessed on my trades. This has allowed time for price continuation on its terms and has reduced the amount of churning trades by exiting trades that were not above entry price after 3 days.

The current underlying and dominant theme to this market is the FED induced liquidity, HFT, and DP. These are subject to change and hence the market structure as well. This is the flux markets will be under, but unless and until all shares traded are cloaked, there will always be a reason to be studious of both price and volume, thinking in terms of who is on the other side of the trade and what is their time frame, as well as studying chart patterns to identify better risk/reward set-ups.

It takes time for positions to be built by large players and I've found that by moving up to a higher time frame and following  momentum stocks with large monthly volume I'm better able to track rapid price increase with underlying supply absorption.  A periodic review of this list to prune those with waning momentum or decreasing price is sufficient to keep my watch list actionable with the greater confidence that I am on the correct side of the order flow for my time frame. The debate of which is more valuable or important or came first I'll leave to others as long as I have a hen that lays eggs I can eat.