Saturday, January 21, 2006

High Volume Steep Declines: A Closer Look

I took a more detailed look at what happens after high volume large declines, and the findings are interesting. Since January, 1998 (N = 2021), I found 36 occasions in SPY in which we had a decline of greater than 1.5% on volume that exceeds the average 60 day daily volume by more than 75%. This fits Friday's trade well, where we declined by 1.82% on 105% of the average 60 day volume.

From the close to the following day's open, the average loss was -.12% (18 up, 18 down), which is weaker than the average move to open of .04% (1104 up, 917 down). Nine of the 36 occasions moved more than 1% up or down from close to open, far more often than normally occurs. This is reflective of above average overnight volatility following the high volume decline.

This above average volatility carries over to the next trading day as well. The average high to low range for the sample overall is 1.60%. For the day after the high volume down day, however, the average trading range has been 3.2%. Indeed, only 4 of the 36 occasions saw a high to low range of under 1.5%. Clearly this leads us to expect some volatile trade on Monday.

In terms of directional edge, although the day after the weak high volume day tends to open weak, by the close this has typically turned around. Three days after the weak high volume day, the market is up by an average .54% (23 up, 13 down), much better than the average three-day gain of .06% (1091 up, 930 down). When we break this down historically, though, a pattern emerges: since 2001, the results following a weak high volume decline have been much worse than from 1998-2000. During the bull market of 1998-2000, weak high volume declines tended to be followed by gains; during the bear market, those same declines tended to cluster, creating multiple high volume declines and subnormal results. For instance, from 2001 - 2005, two days after the high volume large decline we averaged a drop of -.84% (6 up, 12 down), but from 1998 - 2000 we averaged a gain of 1.64% (15 up, 3 down)!

Where does that leave us? The clearest finding from the data is that a high volume weak day tends to produce high volatility prior to the open (overnight session) and during the next day's trade. In a bull market, such declines become short-term opportunities to pick up bargains. In bear markets, such declines feed upon themselves, generating large price drops. How the market responds to Friday will tell us much about the kind of market we're in. I will be monitoring the measures of buying/selling from the Trading Psychology Weblog intraday to gauge whether we're seeing bargain hunting or panic selling.

FWIW, since 2003, we've only had 3 days of large declines on high volume. The next day, the market has been down twice, up once. When we opened lower on those two occasions, we traded lower through the remainder of the day. When we opened higher, we traded modestly lower from open to close. I will need to see tangible evidence of buying before fishing for bargains in Monday's trade.

On a separate note, if you're looking for a light moment, check out my site and you'll see the first article I've ever written for a website to be outright turned down. I can't figure out why...

4 comments:

friskytrade said...

Hi.
In regards to your Jan 21st posting: "It's really important to know who is in the market. One of the huge disadvantages of retail traders is difficulty getting access to that information...."

May i ask, where does one find such information...any links you can suggest???
(i posted this comment here because i could not find an email link anywhere on your site...hope it's ok. My email is friskytrade@yahoo.com.

PS...ROFLMAO re: rejected article!

Brett Steenbarger, Ph.D. said...

Hi,

Thanks for your note. There are a few ways of figuring out what institutions are doing. Professional trading firms, especially those that are members and clear through the major exchanges, have access to the data. Large traders can also gain access through their brokerage firms. Squawk services are available to the trading public (check out www.squawke.com) that broadcast institutional involvement in real time. It is also possible to analyze volume stats from the market to make estimates of institutional presence. I'll write an article on that topic shortly.

Brett

The Scorpion's Den said...

On your article that was rejected, very funny and witty. I don't buy the last item in it though.

Brett Steenbarger, Ph.D. said...

Hi,

Thanks for the note. I appreciate your sentiment regarding the last line of the article, but somehow I don't think it was rejected because of my modesty... :-)

Brett