Saturday, August 23, 2008

Money Flowing Out of Stocks

Recall that dollar volume flow (aka money flow) represents the dollars flowing into or out of a particular stock or market. We look at each transaction in each stock and multiply the transacted price times the volume of that transaction. If the transaction occurred on an uptick, we add it to a cumulative total; if the transaction occurred on a downtick, we subtract it from the cumulative total. That cumulative total at the end of the day is the money that has been flowing into (if the sum is positive) or out of (if the sum is negative) the stock.

For the money flow for the Dow Jones Industrial Average (chart above), I add the money flow figures for each of the 30 components of the Dow to get an overall sense of dollars flowing into or out of the market. (A four-day moving average of money flow is depicted above). This money flow figure on a daily basis significantly correlates with price change in the Dow since 2008 (.57), but obviously does not completely overlap. I have found divergences between money flow and price to be very helpful in tracking market strength, such as the higher bottoms in March and July preceding rallies and the lower highs in May preceding the market decline.

Note how money flows have been quite weak since the market's pullback from its highs earlier this month. Observe also how flows have remained mostly negative throughout 2008; forays into positive territory have been brief. There is little indication from money flow that investors are aggressively putting fresh funds to work in the stock market. Much of what we're seeing in the market's choppiness appears to be sector rotation and a covering of existing positions.
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1 comment:

Ziad said...

Hey Dr. Brett,

I've been giving this a lot of thought and there is still something I'm not quite clear about. Namely, why would a trade at the offer necessarily imply inflow, and one at the bid outflow? Couldn't it easily be that a trade at the offer was a transaction where a long position was being EXITED at the market and a new short was being transacted with a limit offer? If so, that trade on the uptick would actually be outflow instead of inflow. To me it just seems that the only thing that an offer being taken out or bid being hit tells you is which side was being more aggressive.... but they could be being more aggressive in exiting an existing position rather than entering a new one, and thus we can't really say anything about new vs. old capital just from this analysis. What do you think?