Sunday, July 27, 2008

Money Flow: Fewer Sellers, But Still No Influx of Buyers


In my last post, we saw evidence of resilience in the price behavior of smaller cap stocks. I suggested that such resilience can be part of a longer-term bottoming process. Another part of bottoming is seeing an increase in the funds being put to work in the stock market. That is the function of the money flow indicator, which tracks the dollar volume entering or exiting stocks on a daily basis. It does this by tracking every single market transaction in every stock, adding the dollar volume (price times volume) to a cumulative total if the transaction occurs on an uptick and subtracting it from the total if the transaction occurs on a downtick.

Above we see a four-day moving average of money flows into the Dow Jones Industrial stocks. Note how selling dried up from January through March prior to the market's bounce higher and how selling also dried up from the latter part of May through early July prior to recent market bounce. I've found this to be a common pattern: a decrease in buying or selling prior to an intermediate-term market reversal.

Still, a waning of selling is different from an influx of buying. When the market bounced after the March low--and now during the market's recent bounce--we have not sustained days in which dollar inflows have exceeded outflows. The moving average's excursions above the blue zero line (the point at which inflows equal outflows) have been brief. This suggests to me that much of the bounce consists of short covering and asset reallocation, not necessarily fresh funds being put to work in equities. As much as I've been impressed with the resilience of many stock market sectors and styles, I will need to see more evidence of positive flows before concluding that we are out of bearish woods.
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2 comments:

panefsky said...

I've found this to be a common pattern: a decrease in buying or selling prior to an intermediate-term market reversal.

Is Fourier analysis valuable to this setting? Could these assumptions be formalized based on dominant flow frequencies, derived from such an analysis?

Brett Steenbarger, Ph.D. said...

Hi Panefsky,

I'm not familiar with any research in this area.

Brett