I was visiting David Varadi’s blog and came across his recent post about the importance of using volume exhaustion as a guide to shorting. With POMO and QE running roughshod over the backs of short-sellers, any little edge can help, and DV seems to be on to something. Here is the core of his idea:
Curiously, one of the filters that seems to improve entries considerably is the concept of volume exhaustion: when volume reaches a short-term high over the past week or two weeks on short-term market strength, it is likely that buying is close to some peak, and hence is exhausted.
I took his idea, and paired it with his trademark indicator, the DV2, or DVB, to see what would happen.
Here are the rules.¹ No commissions or slippage were included.
- Go long at the close when DVB crosses beneath 20.
- Go short at the close when DVB crosses above 80.
Then I add the volume filter, using the same short rule but requiring volume to be higher than an X day high in order to go short.
Results:
While requiring volume to be greater than a 10 day high in order to short did improve results significantly, I’m concerned that the sample size may be too small to draw any meaningful conclusions. It is hard to tell whether the filter has an edge in this scenario or whether it just limited the system to taking a few lucky shorts.
If nothing else, requiring a volume surge before getting short does certainly limit opportunity, and while The Ben Bernanke is in charge, limiting opportunities to get short is probably a wise decision.
I like DV’s idea and intend to explore it further in the future.
¹Often DV uses this indicator to go short above 50 and long beneath 50. I have altered these parameters a bit.
