How Relative Volume Helps Us Trade and Fade Market Movement

This is the sixth post in the series looking at indicators that I have found useful in tracking the market's short-term behavior.  Previous posts in the series are linked below.  In this post, we look at a measure I call relative volume.  In the chart above, relative volume (red line) is plotted against SPY for Friday, 12/30/16.

Relative volume is actually a ratio of current one-minute volume to the average volume for that minute.  Thus, for instance, if the current volume at 9:39 AM is 200,000 shares and 9:39 AM volume averages 100,000 shares, the relative volume is 2.0.  When we view volume in this manner, we can quickly see if market moves are supported by significant participation.

Notice how relative volume started the day well elevated and stayed elevated for most the session.  This is true for many trend days:  it is the additional participation of directional players that sustains the market move.  The trader watching relative volume early in the day had an excellent tell that this was abnormally high participation--and it was skewed to the downside.

Conversely, days in which relative volume persistently stays below 1.0 are ones in which moves cannot attract meaningful participation.  This leads to frequent reversals of those moves in a range environment.  Very often, we'll see relative volume tail off as market moves mature, as new high or low prices fail to attract added participation.  This frequently precedes reversals, as we saw during the 10 AM hour of trading above.

When price breaks out of a range on sustained elevated relative volume, we have a great indication that the new prices are attracting fresh participation, which makes the breakout less likely to be a fakeout.  

The key to understanding relative volume is that, when we see elevated participation in the market, that elevation typically comes from directional participants.  If we're going to get a momentum/trend move, we need the players to sustain the higher or lower prices.  The waxing and waning of relative volume tells us where the market's auction is attracting activity and where it is shutting it off--an essential distinction for short-term traders.

Previous Posts in the Series:

*  Tracking Instantaneous Demand and Supply

*  Tracking Multiday Market Strength and Weakness

*   Tracking Market Breadth and Strength/Weakness

*  A Unique Application of VWAP to Gauge Market Strength

*  Tracking Market Strength With Intraday New Highs and Lows
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