An Important Takeaway From The Recent Market

This past Monday, we had roughly 92% of all stocks in the Standard and Poors 500 Index trading above their ten-day moving averages.  That is very broad strength.  Just three days later, the percentage trading above their ten-day averages was a touch over 2%.  That is very broad weakness.  All within one week!  (Data from the excellent Index Indicators site).

What we are seeing is a market with an unusual amount of herd behavior.  Many of the market participants that I speak with simply cannot take a lot of heat.  On Thursday alone, the market went down about 6%.  At many hedge funds, that kind of drawdown could knock one out of the game.  When risk limits are tight, traders have to pile into trades and have to run for exits, and that contributes to volatility and market extremes.

A key tell for the market is relative volume (RVol).  When volume expands significantly day over day, that tells us that the herd is active.  For example, volume in SPY on Monday and Tuesday was between 70 and 80 million shares.  On Thursday, we traded over 200 million shares!  When we see volume elevated in the first hour and negative extremes in the advance-decline ratio and the NYSE TICK, we want to think about front-running the herd and we want to think about the possibility of a downside trend day.  Conversely, low relative volume tells us that the herd is not active and that we could see sector rotation. Volume shapes the opportunity set:  that's an important takeaway from the recent market.

Further Reading:

Identifying Trend Days inside the Market

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