What is Most Essential in Markets

This was Mali at 2 AM this morning. It's not much of a conflict when part of you wants to sleep and another part of you wants to cuddle a blind, purring cat. The purr is worth a tired day! It's all about staying focused on what's essential in life.

In markets, it's easy to become focused on non-essentials. We tell ourselves stories about the state of the world or the state of market charts. Far more essential is what buyers and sellers are actually doing in markets. Are there many buyers participating in today's market? Many sellers? What is the relative balance of buyers and sellers, and is that changing? It's all about the auction process.

So let's go to the data. We'll go back to 2012 and look at every transaction in every NYSE stock each day. Those occurring on upticks we will categorize as initiated by buyers. Those occurring on downticks we will categorize as initiated by sellers. The total number of transactions occurring on upticks and downticks, we will call participation in the market. Participation differs from volume, because a given unit of volume can be broken into many transactions or fewer depending upon the sophistication of the execution platform and the urgency of the traders. Increasingly, we're seeing volume broken into pieces, creating multiple transactions. How these transactions occur--on upticks vs. downticks--provides a useful sense for the flow of supply and demand moment to moment.

So at the end of the day, we have a total score of transactions occurring on upticks (buying pressure) and a total score of transactions occurring on downticks (selling pressure). What can we learn from these measures?

If we divide the sample from 2012-present into quartiles, we find out that when daily upticks are lowest, the next 10 days in SPY have averaged a loss of -.05%. When daily upticks have been highest, the next 10 days in SPY have averaged a gain of +1.02%. Heavy buying tends to beget further buying. That's a momentum effect.

If we then look at when we have the fewest downticks, we find that the next 10 days in SPY have averaged a gain of +.13%. When we have the greatest number of downticks, the next 10 days in SPY have averaged a gain of +.96%. Heavy selling tends to beget future buying. That's a value effect.

If we now combine total upticks and total downticks to create our participation measure, we find that when we've had the lowest participation, the next 10 days in SPY have averaged a loss of -.10%. When we've had the highest participation, the next 10 days in SPY have averaged a gain of +1.33%.

So this is what's essential: There are value participants in the marketplace that scoop up stocks when they have traded weakly. There are momentum participants in the marketplace that buy shares when they're moving sharply higher or lower. Market lows are created when value and momentum participants are interacting with one another, first selling falling shares, then scooping up the fallen assets, and then picking up the rising stocks. Market highs are created when prices get to the point where they no longer attract value participants and lose their momentum. There is relatively low participation at those times.

This is why, when SPY volume has been lowest, the next 10 days in SPY have averaged a loss of -.24%. When volume has been highest, the next 10 days have averaged a gain of +1.15%.

Who is in the market? What are they doing? How is their behavior shifting over time? Those are keys to understanding markets.

Now I'll focus on another essential: sleep!

Further Reading: Reading Market Footprints
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