Volume Confirms Price

NOTE:  This Trading alert was originally posted at Ritholtz Research & Analytics on Fri 7/31/2006 11:27 aM EDT; An email went out to subscribers alerting them shortly there after.

This is posted here not as investing advice, but
rather as an example of a trading call for potential subscribers. We
expect to post future advisories in a similar manner — after the call,
but in the correct chronological location on the blog.

It’s an old Wall Street saying, and its one of the few that’s true: Volume Confirms Price

Why is that? Because volume reveals what the level of institutional involvement is. And Institutional participation is important for several reasons:

1.    Mutual funds, Trusts, and hedge funds account for more than 50% of the trading volume on NYSE;
2.    Institutions make buys or sells over longer periods of time, averaging into their positions. That is what accounts for persistency of trends;
3.    Monthly contributions via 401k and other vehicles constantly force them to put money to work;

A market surge on high volume tells us more than just the price action does alone. As individuals, you get to legally front run the big boys. When we see them buying with both fists, it usually lasts more than a few days. Big volume moves tells us that institutions have conviction – a level of certainty.

Without their active involvement, rallies simply don’t go very far.

Friday’s rally is a perfect example – it was actually on lighter volume than the prior two days. In fact, most of Friday’s rally occurred between 10 and 11:30. That’s not exactly what one calls inspiring. The rally lacked the sort of institutional conviction that leads to lasting improvement in prices.

This doesn’t mean that we ignore the price action. It looks like July has become a round trip – Price levels are back at just about where they were in July 1. That implies a lot of wasted energy on the part of the Bulls.

However, we always respect the price action (even if its short term in nature), and will reverse ourselves when we see the requisite proof that a credible rally – meaning more than a bounce of a week or two – is in the offing. That can happen in at least two ways:

Last week, I mentioned that one of the ways markets create reversals and buying opportunities is by becoming deeply oversold. Another way is simply time:  After enough time elapses, markets work off their overbought conditions. Time also improves charts, as downtrends get broken via sideways activity. This could very well lead to a brief summer rally – somewhere in August perhaps?

Our longer term Marco-economic expectations are playing out according to script. We remain negative later this year – despite the recent improvement in price action.

Watch these four asset classes – gold, U.S. dollar, oil/nat. gas,  and stock markets – all moving up together.  That is very unusual at this stage of the economic/market cycle. They should decouple at some time in the not too distant future.

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