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- Volume Precedes Price
Good Morning!
This is the Jumping Cholla (CHOY-uh). The newsletter that turns options market insights into a fun, easy-to-read email that helps you reduce your chances of getting pricked while trading!
Quote of the day:
"Volume precedes price"
-Age old adage
You know all those people on TV who talk about being bullish or bearish? That's just entertainment!
The only way to truly express an opinion on a market is to put your money where your mouth is! Trade volume at a specific price and that's what hits the ticker tape!
This cute graph of a supply and demand curve is what fundamentally occurs while trading. The market is "figuring out" how much quantity can be bought or sold at a given price...it just happens much, much faster than any other business in the world!
Today, we'll dive into the basic economics of volume and price, and what to look for while trading.
BANG for Your Buck:
| 1/17/2023 SPX = 3999.09 | Handles of Movement | 1-Day Implied % Move |
|---|---|---|
| BANG (intraday) | 46 | 1.2% |
| BANG (weekly) | 102 | 2.5% |
The market nearly pinned 4000 at the close on Friday! I don't usually advocate for playing the butterfly lotto ticket, but c'mon man, Friday was the perfect setup!
Things to look for this week
Large shorter term option positioning at 4000 level in SPX
This creates larger impacts on dealers' (bookies) need to reposition in order to remain market neutral (also known as hedging)
Dealers seem to be net long the calls around here, meaning as the market rallies above 4000, they need to sell SPX underlying. As the market sells off below 4000, they need to buy SPX underlying
4000 level should act as temporary oscillation point (this can change with a "re-pricing shock" such as news)
VIX < 20 & implied volatility via options is less than realized volatility via underlying movement.
This has generally marked a short-term topping process, and the expectation of a move lower
Moves greater than BANG, in either direction, need a catalyst
Reports / News
Couple of Federal Reserve talking heads spewing rhetoric
Manufacturing numbers, homebuilders, building permits, building starts, and jobless claims
Bunch of Q4 earnings reports
Remember, we don't care about what these numbers say, rather how the market reacts to them.
World Economic Forum
A lot of "do what I say, and not what I do" types will be planning your future for ya!
There are some big players on panels and giving speeches e.g., so the market may react to something Larry Fink of Blackrock says about the economy. Definitely all new info that no one else knows about in advance! (wink wink)
The Supply and Demand of Volume
The phrase "volume precedes price" is a trading adage that refers to the idea that changes in trading volume often precede changes in stock prices. It's simple econ crap (which we all know you slept through!)
In the graphs below, both curves represent volume. Price is where supply volume and demand volume intersect!
One of our favorite quotes "the market goes up when there are more buyers than sellers."
Lol, nope! There is always a seller for every buyer, otherwise a trade cannot occur, but the price must change to attract more selling volume.
As the willingness to sell increases, the only way to attract buyers to satisfy the selling supply is to do the transaction to a lower price.
This is price discovery: feeling out who wants to execute more volume than the other and adjusting their willing buy or sell price for a specified volume.
Make Me a Better Trader
Okay, let's move on from the econ homework.
Reading Volume on the Bid-Ask Spread
What did I tell you?! Only volume that prints matters! Everything else might as well be a talking head on CNBC!
The volume on the bid or ask doesn't mean much...it is literally just advertising a bias.
In the modern age of high frequency "cancel/replace" orders, shown volume at other prices is basically there to convince other participants that their bullish or bearish bias is correct before anything actually occurs. (cute little trick, right?!)
Low Volume Doesn't Mean Low Conviction
When the price moves in one direction, is trading volume higher or lower?
Generally, it's lower!
As price is "being discovered", one side of the equation does not have enough willing participants to satisfy the other until the price gets to an attractive level aka not enough volume.
Another way to think about it: If you were always the seller, and everyone keeps wanting to buy, why wouldn't you raise your prices and sell fewer until it gets to a price you like?! This leads into a much larger topic of scaling (hint: the above graphs imply traders don't scale linearly)
Does this mean that directional move will fail?
No, and it doesn't mean that it will continue either!
Do not get in the habit of justifying your bias by saying stuff like "that move was on low volume".