Friday’s volume surge was greater than 2.75 times the 50 day average volume. If we treat volume as an indicator, and ignore all other variables, what does a surge in volume portend for the short and intermediate terms?
First, since everyone is concerned with the next several days, let’s look at next day, two day, and three day returns. To be clear, I have calculated returns this way: Two day returns is the return on day two after the volume surge. It is NOT the return of the first AND second day after the volume surge. The same calculation is used for the three day return.
Next Day Return
Average Next Day Return = 0.17%
% of Winners = 42.31%
Second Day Returns
Average Second Day Return = -o.08%
% of Winners = 55.10%
Average Third Day Return = 0.14%
% of Winners = 54.35%
What SPY does Monday, Tuesday, and Wednesday is hard to predict. History leans towards positive returns, but the edge is not strong. With the S&P downgrade, all analysis of the past might be meaningless.
What stands out is recent performance. Looking at the last 15 or so occurrences, note how volatile the market has become after a surge in volume. I suspect that if I dug deeper we would see that many volume surges occur during bear markets or downtrends, where we would expect a great increase in volatility. Volume just doesn’t seem to surge near tops or during uptrends the way it does during a downtrend or bear market phase.
There is an edge though, but it doesn’t show up in the short-term. It is very obvious in an intermediate term analysis. The chart below was generated by assuming one bought SPY at the close when the volume surged to greater than 2.75x the 50 day average volume. No commissions or slippage were included, and all SPY history was used.
While we are living and trading during what seems to be an unprecedented time, in the past, large volume surges have led to a strong upside edge in the intermediate term.
It is important to remember that the chart above has combined all the trades to create an average. While the average is very bullish, we may find ourselves staring down a -4% to -8% move down over the next few days. I guess we should be optimistic and realize that we could also see a +5% upside move over the next few days. Since a bounce is due, I will go against my gut and lean towards the upside rather than more downside. Again, I’m using past data, absent an S&P downgrade of the credit rating of the United States of America.
Lastly, sustained bear markets are rare events. While they are few and far between, should the market be starting another bear phase, any bounce should be used to go to cash or initiate shorts.