RETALLS DE PREMSA

rarely concluded a swing move — that is, there was usually follow-through movement the next day in the same direction. However, the article also showed the higher the percentage of dominant volume, the smaller the average follow-through move. This makes sense if we consider the market is com- posed of a relatively stable number of players on a day-to-day basis, and once the majority of traders and investors make their commitments (reflected by a high level of relative up or down volume), the market will run out of steam and lose momentum or retrace.

Which came first: High or low?

The previous month’s article analyzed the follow-through ques- tion in terms of exiting trades: Does the follow-through implied by a certain relative volume reading provide a good guide for getting out of a position immediately or staying in for addition- al profits?

Other questions still need to be answered: Based on the rela- tive volume, can you enter a trade on the close in anticipation of the average follow-through move (or some percentage of it) to occur in the S&P 500 futures contract the following trading ses- sion? And more importantly, what would be the average risk?

There are two issues to consider here: First, if the market closed with a high percentage of up volume, how often does the S&P reach (the next day) its high before making its low. If the market established the low first, going long on the previ- ous day’s close might not present such an attractive buying opportunity because you might have to suffer through an adverse market move before getting a chance to realize a prof- it. The opposite is true for down-volume days: You would pre- fer the follow-through day to hit its low before its high.

Second, if the market does not first reach its high after a dominant up-volume day or its low after a dominant down- volume day, how much does the market tend to move against the expected trend? This will deter-

mine how much risk you must assume to attain a potential reward. Like the previous study, the fol- lowing analysis of S&P futures data (including the Globex session) groups the data according to the dominant relative volume level for the day in ranges of 50 to 59.99 per- cent, 60 to 69.99 percent, 70 to 79.99 percent and 80 to 89.99 percent. Then, for each range, we determine how often the market first makes its high or low on the following day. The results

Figure 1 (opposite page) shows the difference between the close and the next day’s high and low for the 50-59.99 percent up-volume group, sorted by which price was estab- lished first, the low (on the left) or the high (on the right).

The up volume was between 50

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High established first

Low established first

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 Di ffe re nc e bt wn . c lo se a nd n ext d ay ’s hi gh o r l ow 45 35 25 15 5 -5 -15 -25 -35 -45

In the 60- to 69.99-percent up-volume group, the percentage of follow-through days on which the market made its intraday high before the intraday low increased to 61 percent.

FIGURE 2 60- TO 69.99-PERCENT UP-VOLUME DAYS

Close-to-high move Close-to-low move

This breakdown of the price moves for the different dom- inant up-volume ranges reveals an interesting fact: The average up moves (from the close to the following high) were higher on those days the market made its daily low before its daily high.

TABLE 1 AVERAGE CLOSE-TO-HIGH AND CLOSE-TO-LOW

MOVES FOR UP-VOLUME DAYS

High (Avg.) Low (Avg.) 50-59.99% Up Low first 15.47 -6.22 High first 4.36 -16.18 60-69.99% Up Low first 10.70 -4.86 High first 7.00 -11.74 70-79.99% Up Low first 12.53 -4.91 High first 4.94 -16.16 80-89.99% Up Low first 10.20 -6.23 High first 4.28 -10.08

The average close-to-low moves were generally bigger when the market made its daily high before its daily low. The tendencies in Tables 1 and 2 suggest it may be worth- while to consider a pullback strategy that goes long on the follow-through day when price makes an intraday low, or goes short when price makes an intraday high.

TABLE 2 AVERAGE CLOSE-TO-HIGH AND CLOSE-TO-LOW

MOVES FOR DOWN-VOLUME DAYS

High (Avg.) Low (Avg.) 50-59.99% Down Low first 15.57 -5.20

High first 4.88 -14.28 60-69.99% Down Low first 14.82 -5.80 High first 4.38 -15.71 70-79.99% Down Low first 13.87 -4.65 High first 5.65 -11.92 80-89.99% Down Low first 14.24 -5.95 High first 6.85 -14.38

and 59.99 percent on 37 days. The high occurred first on 21 (57 percent) of those days and the low occurred first on the 16 remaining days. When the high occurred first, the average dif- ference between the previous close and the high was 4.36 points.

Tables 1 and 2 (p. 50) break down the average differences between the highs and the closes and the lows and the closes, according to whether the low occurred first or the high occurred first.

Entering trades

From here, it is easier to gauge the value of entering a trade on the close based on the relative volume. “Following through in the S&Ps” showed that when the relative up volume was in the 50- to 59.99-percent range, price hit a 2.5-point profit target 84 percent of the time the next day; a five-point target was hit 57

percent of the time, and a 7.5-percent target was reached only 49 percent of the time.

The substantial difference between the 2.5 target (hit 84 percent of the time) and a 5-point target (hit just 57 percent of the time) makes sense in light of information in Table 1: When the high did occur first (21 of the 37 days), the average move was just 4.36 points.

Figure 1 shows this as well. The high occurred first on bars 17 through 37. We can see how much smaller the green bars (representing the difference between the high and the previous day’s close) are in this group.

Table 1 shows if the low occurred first, the average difference between the close and the low was -6.22 points, with the worst instance being -15.47 points (see Figure 1). So, if you were looking to take a 2.5-point profit from a long position, you had the possibility of having to weather, on average, an adverse move more than twice the size of your desired profit if the high did not occur first.

Figures 2 through 8 show compara- ble breakdowns of the remaining dom- inant up-volume and down-volume ranges. Figure 2 (p. 50) reveals the high occurred first 61 percent of the time in the 60- to 69.99-percent up-volume group, a slight improvement over the 50- to 59.99-percent group. Also, the difference between the close and the low (regardless of whether the high or low occurred first) was better than the 50- to 59.99-percent group (-4.86 and - 11.74 vs. -6.22 and -16.18). This implies when the market closes with a higher degree of conviction — as indicated by greater relative up volume — the mar- ket performs better the following day.

Figure 3 shows the 70- to 79.99-percent up-volume group was split 50 percent between days the high occurred first and days the low occurred first. Figure 4, the 80- to 89.99-percent up-volume group, shows the high occurred first 58 percent of the time, but the average follow-through for the difference between the close and the high was the lowest of the four groups, implying the market is overbought when the up-vol- ume percentage is this extreme.

Down-volume days

Figure 5 shows the 50- to 59.99-percent down-volume group. To consider a short position on the close, we would look for evi- dence the low occurs before the high on the following days. However the low occurred first only 42 percent of the time. (Perhaps this is a “hope springs eternal” phenomenon, in that

51 www.activetradermag.com • January 2004 • ACTIVE TRADER

High established first

Low established first

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 Di ffe re nc e bt wn . c lo se a nd n ext d ay ’s hi gh o r l ow 45 35 25 15 5 -5 -15 -25 -35 -45

The S&P E-Mini made its intraday high before its low 58 percent of the time, but those close-to-high follow-through moves were the smallest of any group.

FIGURE 4 80- TO 89.99-PERCENT UP-VOLUME DAYS

Close-to-high move Close-to-low move

High established first

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 Di ffe re nc e bt wn . c lo se a nd n ext d ay ’s hi gh o r l ow 45 35 25 15 5 -5 -15 -25 -35 -45

The follow-through days were split evenly between those that made the intraday high first and those that made the intraday low first.

FIGURE 3 70- TO 79.99-PERCENT UP-VOLUME DAYS

Close-to-high move Close-to-low move

the market tends to begin the day trad- ing to the upside, even thought the pre- vious day’s activity was slightly more dominated by sellers, but then sets the high for the day and falls back down.) Figure 6, the 60- to 69.99-percent down-volume group, is a little more what you would expect, in that the low occurred first 52 percent of the time. Table 2 shows the largest average drop (-15.71 points) for the down volume group happened when the high was set first in the 60- to 60.99-percent down- volume group.

Figure 7 (p. 53), the 70- to 79.99-per- cent down-volume group, is also split 50-50 between the low or the high being set first. However, if the low is set first, this group has the lowest average difference (-4.65 points) between the low and the previous day’s close.

Finally, Figure 8 (p. 53), the 80- to 89.99-percent down-volume group, shows the low was hit first 66 percent of the time. This data appears to indi- cate likely follow-through the next day — perhaps panic selling because of the amount of heavy selling the previous day.

Going the opposite direction: Pullback possibilities?

At this point, the likelihood of follow- through movement in the direction indicated by the dominant volume seems like a coin toss. If you used any- thing but the 2.5-point target, the potential reward was not worth the risk.

But what if you used a more classic pullback approach of buying after the low occurred first following a domi- nant up-volume day, or selling when the high occurred first after a dominant

down-volume day, in anticipation of higher prices?

Figure 9 (p. 53) draws on some of the data from Tables 1 and 2. Here we will look at the data from the perspective of buying a pullback or selling a rally. The first green bar is the average difference between the close and the high from the 50- to 59.99- percent up-volume group for those days the low was made first. The first red bar is the absolute value of the average dif- ference between the close and the low for the days the high occurred first from the 50- to 59.99-percent down-volume group. The two bars are similar in height.

The second pair of histograms represents the same price measurements from the 60- to 69.99-percent up- and down-vol- ume groups. Interestingly, the market appears to really drop following a down volume day if the high is made first.

The third pair of histograms is from the 70 to 79.99 percent

up and down volume. Again, they are closely matched. The fourth pair is from the 80- to 89.99-percent group.

Looking at all four pairs, it is interesting that the green bars are somewhat lower from left to right, supporting the notion that up volume represents new buying, and that as more commitments are made the follow-through the next day tapers off as capital is spent. However, when the market is falling, the average move- ment does not taper off in the same fashion because it doesn’t cost anything to get out of a long position.

Tables 1 and 2 also reveal something about the typical behav- ior if the market fails to generate follow-through activity. For example, for the 70- to 79.99-percent up-volume group, the average move from the close to the following high is 12.53 points if the low occurs first; if the high occurs first, the average move from the close to the following day’s low is -16.16 points.

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High established first

Low established first

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 Di ffe re nc e bt wn . c lo se a nd n ext d ay ’s hi gh o r l ow 45 35 25 15 5 -5 -15 -25 -35 -45

On days following dominant down-volume readings between 50 and 59.99 percent, the market made its intraday low before the intraday high only 42 percent of the time.

FIGURE 5 50- TO 59.99-PERCENT DOWN-VOLUME DAYS

High established first

Low established first

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 Di ffe re nc e bt wn . c lo se a nd n ext d ay ’s hi gh o r l ow 45 35 25 15 5 -5 -15 -25 -35 -45

In this down-volume group, the percentage of days on which the low was established first increased to 52 percent.

FIGURE 6 60- TO 69.99-PERCENT DOWN-VOLUME DAYS

Close-to-high move Close-to-low move

This indicates there was a great deal of capital committed the previ- ous day and when the market topped out with little follow- through (an average close-to-high move of just 4.94 points) when the high occurred first, the selling pres- sure overwhelmed whatever bid was still there. That is, a lot of traders were easily forced out of positions placed the previous day.

We see similar results from the 50- to 59.99-percent up-volume group. The kicker is this negative price action following an up-vol- ume day is worse than that in Table 2, which shows the down-volume group statistics and is where we would expect larger numbers. This is why one should never trade on hope, and should always use stops. The ins and outs

The studies from this article and its predecessor provide useful infor- mation for trading plans. The first article discussed the potential advantages of holding a position until the next close rather than the current close if the volume statistics supported it. The goal was only an additional 2.5 points of profit, like- ly to be hit.

Here though, a critical compo- nent to employing this volume analysis is factoring in the risk depending on whether the high or low comes first. The best opportunities probably are available if you use some technical pattern setup or oscillator that can indicate there is a good probability the low or high for the ses- sion is occurring. This could then be acted upon in the context of the expected move derived from the dominant volume statis- tics.

In addition, this work could be done in the framework of the overall trend. For example, if the trend was up (based on just a simple moving average), the previous day’s up volume was 62 percent of the total volume and the market was down on the day, then look for an indication the low for the day is being established. You likely have a very good risk-reward trade opportunity.

Finally, if the market fails to follow through in the anticipat- ed direction and the high or low that occurs first is counter to the anticipated direction (and is near the average values in Tables 1 and 2), there is greater potential for a move in the opposite direction than a move in the expected direction.

_Ý

50-59.99% 60-69.99% 70-79.99% 80-89.99%

C-H (when low C-L (when high

occurs first) occurs first)

Av g. d iff . b tw n. clo se a nd h igh o r l ow 18.00 16.00 14.00 12.00 10.00 8.00 6.00 4.00 2.00 0.00

While the green bars are somewhat lower the greater the percentage of up/down volume, the red bars do not follow a similar pattern. This supports the theory that buying tapers off as capital is spent, but selling remains constant because it doesn’t cost anything to get out of a long position.

FIGURE 9 PULLBACK POSSIBILITIES