Deep Thoughts on the Market “Melt Up” and Lack of Volume
Ever since the March 2009 bottom, traders have expressed caution on the way up due to the underwhelming upside volume, despite the fact that we are now 70% above lows even after a large pull-in. Although volume on a move is indicative of conviction, there are far more factors that come in play than just volume alone. Too many are left on the sidelines waiting for volume to “confirm” the move.
In early February 2010, as the market was in the process of bottoming and embarking on an aggressive rally, Rob Hanna at Quantifiable Edges posted the following chart:
On each down move, the market moved swiftly with expanding volume on each leg lower. Meanwhile, each time the market rallied, the aggressive volume from the down-move dissipated and the market “melted up” lacking what many would call “conviction to the upside.”
Since this particular breakdown started in April, I have been looking for both volatility and volume to subside as an indicator to get even more long. The answer as to why that is lies in the psychology of breakdowns verse breakouts. When the market broke the much ballyhooed 1040 level on the S&P in late June on less volume than each of the preceding lows, that was a sign to me that the emotion of breakdown had largely subsided, despite price moving lower. Let’s launch into a brief discussion of the emotions that traders and investors experience in the different phases of these market cycles in order to gain a clearer perspective as to how and why the market is moving as it is.
The Breakdown Phase:
However, between 1945 and 2007, by and large, investors were rewarded for buying aggressive market down-moves. Investors were taught to step in while the Bear was growling and sell when the Bull was roaring. All that changed in 2007-2009 when investors lost faith in just about all asset classes. Equal opportunity selling ensued, and what were perceived as “valuation levels” ended up turning what in the past would be a prudent decisions, into nightmarish losses.
These are new and fresh wounds in the minds of the collective equity market investor. Therefore, when markets breakdown, there is far more emotion to the rush out of equities than in the past. In the back of each investors head is that lingering “what if…” concern over whether this is the time the breakdown in asset classes will reemerge. Nowadays, when people want out of markets they sell and ask questions later. As we have learned all too well, the risk in thinking and waiting can far outweigh the risk in staying exposed to a sell-off.
We saw this emotion play out recently. People gain exposure in legitimate mainstream media circles warning of the market’s “all but certain” plunge to Dow 1,000 (Robert Prechter is just one such example). Why is it that one can “legitimately” make such a claim, while those who say we will not crash, and may rally 15-20% receive a rash of hate mail and are labeled as crazy, misguided and misleading ? Such are the emotions of the market.
The Bottom into a Rally:
At the end the last two large down-moves–early February and this recent move around early June–markets stayed low for some time and made aggressive moves in both directions for days and weeks, convincing both Bulls and Bears alike that they were right. There were fake breakdowns and fake breakouts galore; however, the one notable trend was that as the market stayed down and in a tight range, volume receded and volatility subsided. Complacency with price, and not volume, was the signal to get long.
While this is an oversimplification, stocks can go up in two ways: buyers can proactively bid shares higher, or sellers can passively choose to sell at higher prices. Proactive bidding higher obviously generates volume to the upside, while seller passivity can largely go unnoticed. The rallies off of these down-moves result primarily from seller passivity, therefore the beginning stages of these moves have largely gone unnoticed. On the way down, sellers are willing to step lower and take whatever price they can get to get out. However, once the emotion of panic subsides, the active sellers get washed out and remaining equity holders start waiting to see what will happen next.
This wait and see is an important step in the bottoming process. As the pressure subsides, sellers slowly start lifting their offers–by lift I do not necessarily mean raise their prices, what had been for sale may simply no longer be for sale. In order to move prices back up, it takes far less volume to lift equity prices.
What to Expect:
For those looking for volume once again, be ready for some disappointment. People don’t “panic” into markets like they panic out. I do believe that many are largely underexposed to equities, considering the risk/reward ratio in bond markets and the fact that the risk of a double dip has been greatly over-exaggerated. However, that does not automatically translate into a surge of upside volume for the market. When big institutions buy, they slowly and steadily accumulate stakes in their desired investments. Getting long is a process, not an event, hence the saying “markets go up on an escalator and down on an elevator.”