Thursday, October 13, 2011

Rally not confirmed by volume

As stocks continued to rally into a resistance zone yesterday, the lack of confirmation from volume indicators suggest that resistance is likely to hold. The chart below of SPY shows that this October rally has been a low volume rally. In fact, volume has been so low that yesterday's volume was barely above Monday's Columbus Day semi-holiday volume.

Recall what I wrote before about the William O'Neill technique for spotting confirmation of a bottom:
[Y]ou’ll want to see a market confirmation.

That starts when one of the three major indexes begins to rally. That’s day one. Next, wait two days. The market often needs time to digest its initial gains. Make sure the index doesn’t undercut its low. If it does, start counting over again.

Starting on day four of the cycle, look for a follow-through session. That occurs when the Dow, Nasdaq or S+P 500 jumps at least 2% on higher volume than the previous day. Ideally trade will also exceed its 50-day average. The bigger the price and volume moves, the better.

The strongest follow-throughs occur between days four and seven of the attempted rally. Follow-throughs after the 10th day become less significant.
We just passed Day 7. Where's the rally on volume?

Echoes of 2008?
I also noticed similar instances of low volume rallies during the Summer of 2008 just before the roof caved in.

While these analogues are useful examples, we also have to remember that history doesn't repeat itself, it rhymes.

The current stock market rally has been sparked by headlines of possible resolutions of the eurozone crisis. The euro has rallied on the news. A glance at the chart of the euro, however, shows that it kissed the underside of two Fibonacci retracement levels.

To reinforce my conviction that the latest bullish impulse is not sustainable, consider the weekly latest comment published on Monday from Mary Ann Bartels, Chief Technical Analyst at Bank of America/Merrill Lynch [emphasis added]:
The bulls finally make a stand. Last Tuesday’s low 1075 on the S&P 500 marked a lower volume test of the early August low near 1100 and this is an early sign that the US equity market is trying to form a bottom. This is encouraging, but the risk is that the market has not yet seen the explosion in volume that typically comes with a climactic capitulation. In addition, last Thursday’s and Monday’s 90% up days occurred on lackluster volume. This suggests a lack of conviction from the bulls and likely points to short covering, which is not the recipe for a sustainable rally.
I continue to believe that traders should be fading this rally, not buying into its strength.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.


Eric said...

Don't you mean above, "To reinforce my conviction that the latest bullish impulse is NOT sustainable"?

FGH said...

Cam, I love your work...did you mean that your conviction is that the current market rally is NOT sustainable?

Humble Student of the Markets said...

Yes you are correct. The post has been correct.

Humble Student of the Markets said...
This comment has been removed by the author.
Tiho said...

I have to admit, your volume thesis written here makes absolutely no sense. I think you are teaching people wrong things and I think the "volume rally" is just a myth that people keep bringing up. Constantly people keep saying "this rally is not confirmed by volume".

All that matters for bulls is that volume falls down from intense selling pressure levels. When volume spikes during a huge sell off like during May 2010 or August 2011 - we call that a "wash out". Market price starts to rally when volume starts falling, meaning selling pressure is diminishing. That is a good sign for bulls, even if its just temporary.

Do you remember any rally that has been confirmed by volume in the last decade? Voluming was decking the whole time during the 2003-2007 bull market. After March 09 everyone said that volume was not present. Afterwards, from August 2010 everyone said volume didn't confirm the rally. In 2003 to 07 and from March 09 market doubled. Since August 2010 to May 2011 market went up 20 to 30%.

For example, look at the recent UBS Technical Analysis Newsletter published on 11th of October 2011 - link here. On page 3, UBS strategist says:

"First we need to see declining selling pressure before we get a more meaningful low and a buying set-up. Although in the last 2 weeks we had several 95% down volume events, the overall selling pressure has been deteriorating and this is typically what we see prior to important market bottoms."

Like I said, your analysis makes no sense. Bulls actually won't to see decreasing volume, which indicating falling selling pressure and that bears are losing control. It takes a lot of volume to move markets down like in August that swiftly and that quickly.

On top of that, don't you think ETFs have something to do with this? All global stock exchanges are losing business as volume is dying down. Don't you see them all merging between each other to cut costs and survive in these bought times.

I hope this whole "volume is missing from the rally" myth just vanishes already. The whole argument just resembles perma-bear outlook.

Humble Student of the Markets said...

Tiho -

Remember the first rule of technical analysis: Volume precedes price.