Monday, March 8, 2010
Most professional traders asked themselves the same question during last week's stock rally:
How is the market rising when I'm not buying stocks – and neither are any of my friends?
I have a chart for you showing why many of the smartest traders I know are asking themselves this question... and why they expect the market to head lower, at least in the short term.
Below is a chart that displays how some professional traders view the market. It shows the past nine months of trading in the big S&P 500 fund (SPY). Many days, this is the most frequently traded security on the market. It moves in lockstep with the benchmark S&P 500 index.
You'll notice this chart has more to it than the simple "line charts" you often see on television or in the newspaper. This chart contains much more information, which you can use to make smarter trades.
At the bottom of the chart, you'll see a series of red and black bars. These bars represent the trading volume in any given day. It's a visual representation of how much power the buyers have, versus how much power the sellers have. Red bars mark the trading volume on declining days; black bars mark the trading volume on advancing days. The taller the bar, the greater the volume.
As you can see, selling volume surged during several periods in September and October. This mass dumping of stocks is marked by (1). This burst of selling pressure is called "distribution."
After this dumping, the market went on to register new highs during November and December. This rally had no substantial buying power behind it, marked by the declining volume line (2). It's like someone threw a party and nobody showed up.
Selling power returned in a big way in mid-January... when the market registered several big declines on the biggest volume of the past six months (3). More punches to the market's gut. More distribution.
Then, in mid-February, the market managed to kick off another rally... which has brought the S&P within a whisker of its January high. But as you can see (4), this was another party that nobody attended. Volume was pathetic.
If you have heavy exposure to stocks, you should be concerned about this weak, low-volume rally. You see, the market must have a constant inflow of new money from giant investors like mutual funds, hedge funds, and pension funds in order to remain healthy. These are the folks who control billion-dollar portfolios. They are the "elephants"... and they are not buying into the market in any meaningful way.
Studying volume is no magic bullet for stock market profits. It's a "secondary indicator," not a primary indicator like price or valuation (stocks are expensive, by the way). But it is a useful gauge on your dashboard. And right now, volume is saying this rally is standing on feeble legs.
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