Volume and Sentiment Are Telling us Something
As an avid follower of volume I look for trends to help define direction. In general, stocks trading higher on strong volume are bullish while trading lower on higher volume would be bearish. The same dynamics are set for up on weak volume (bearish) and down on weak volume (bullish). Taken as a particular data point is useful but on the whole a trend is established or dictated by multiple occurrences.
Recently the higher volume has occurred on down days – even off the chart selling we’ve seen repeatedly since late January. You can cite any reason you wish – Middle East unrest, inflation, fiscal cliff, taxes – they are only reasons and excuses. After all, the market has really been on a non-stop tear since early June – who could blame anyone for taking some off the table. However, the last few weeks have shown a nice, robust rally off the Nov 7 lows – but on very low volume.
I would have suspected some big time selling to be followed up with solid buying – stocks in the hands of strong holders. That hasn’t been the case – and here we are in December. Critical? Certainly, as earnings season is only a month away we like to see some conviction. It’s just not there. Perhaps when some of the issues and matters are settled we’ll see some good buying come back in, but for now listen and pay attention to the market – which is telling you to stay cautious when the buyers are not active.
There are a few solid sentiment indicators that show me where markets may be headed. Chief among them is the VIX, and as we see from the chart below the crowd is showing complacency (relative to historical standards). Should that worry us? We have seen the fear of a big drop mostly removed due to what much has been done by the Fed, Europe and other central banks. Buying when the VIX is coming down is not usually a good move, especially when in a tight range. I have advocated buying protection here as it is relatively cheap. Few are interesting in buying puts these days to protect their positions, but it’s never a bad thing to buy some insurance.
The put/call ratio is another great tool that can signals shifts in sentiment. The chart below (equity only put/call) shows consistently low readings, where puts are not actively being played (same message as the VIX). What to do? As a trend trader I’ll go with it until it’s not working, but these signs (volume and sentiment) should have us all on alert for a quick change emotions.
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