Volume Confirmation Signals

A quantitative, statistical measure developed by MarketScalpel to identify exceptional buying and selling activity.

The signals are based on a statistical comparison between the change in price at the sector level the and the Money Flow (the day’s change in price multiplied by the day’s volume at the individual stock level and then aggregated to the sector level).

If the normalized Money Flow exceeds the normalized price change and in the same direction, this generates a positive Volume Confirmation signal for sector price gains and a negative signal for sector price declines.

The signal also has a breadth component (so that an individual stock alone cannot generate a signal) and is normalized for price volatility at the sector (and stock) levels. Signals are shown as:

• 1-day signals:

  Intuitively represent whether there is an excess amount of volume accompanying price change - either up or down - on the day. This tends to be a more volatile measure but can nevertheless be an early warning sign of reversals (or trend confirmation)

• 2-day signals with breadth confirmation:

  Are more stable and typically capture whether a 1-day signal reversal from one day to the next is strong enough to generate a 2-day signal on the second day. The 2-day signal, when above 0.275 (or below -0.275), is statistically significant for forecasting future sector returns

Signal Interpretation

The 2-day signal for the overall market (All Stocks Index) is a statistically significant forecasting factor with a t-stat >1.6 in a single factor regression against total market returns.

For individual sub-sectors, the signals should be viewed both on a standalone basis and also in the context of related sectors and the overall market.

For example, there may be a positive signal in Technology Hardware driven by a positive signal in the Semiconductors industry, while another Technology Hardware sub-sector such as Computer Hardware may not have generated a signal.

Computer Hardware is nevertheless likely to be affected by signals in related sectors simply by way of sector price index correlation.

The absence of signals can also be significant. For example, a positive signal on an up-day followed by no signal on a down-day typically implies that the up-trend is still in place.

Volume confirmation can be thought of as pinpointing areas of active accumulation and distribution. The key to interpretation is to understand whether they indicate the beginning or the end of a trend, or merely a minor counter-trend consolidation area.

While signals are generally indicative of continued momentum, there are instances where contrarian signals emerge, particularly at a blow-off top or a capitulation bottom in individual sectors. This is where cycle analysis, as well as available volume and breadth data, play important roles.

Of course, the emergence of signals generally directs the attention towards sectors (and stocks) worthy of closer scrutiny.

Relative Sector Rankings

MarketScalpel's extensive data resources allow sectors to be ranked in various ways.  The most widely used method we employ is ranking based on Volume Confirmation Signals that are presented in two ways:

• Based on a 1-month exponential moving average of volume confirmation signals. This provides a good approximation of the recent status of sector strength and weakness backed up by meaningful volume confirmation but has a tendency to be slow moving as a forecasting factor
• Based on the 1-week exponential moving average of Volume Confirmation signals. This is the best measure of current confirmed sector trends and is the ranking reported in the sector overview and sector stock component tables in the web-based research platform

MarketScalpel also allows ranking purely in a price index basis and a comparison of the volume confirmation rankings can provide interesting insight; a price ranking greatly in excess of the volume confirmation ranking will typically indicate potential vulnerability and vice versa.