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Volume Confirmation Signals: Identifying Significant Activity

Volume Confirmation Signals are a quantitative, statistical measure developed by MarketScalpel to identify exceptional buying and selling activity.

Evaluating Sector Money-Flow & Breadth

The signals are based on a statistical comparison between the change in price at the sector level and the Money Flow (the days change in price multiplied by the days 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

Volume Confirmation 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 Semiconductors, 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 and  sentiment data play important roles in assisting interpretation.

Volume Confirmation Sector Rankings

The Market Navigator top-down analysis tools - Heatmaps and Sector Overview Tables - provide the facility to rank subsectors and industry groups respectively based on Volume Confirmation Signals.  These are available in two forms:

  • 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 tables in the web-based research platform

These rankings provide valuable insights in their own right, but they may also be used in conjunction with rankings based on price performance; where a price ranking greatly exceeds the volume confirmation ranking a potential vulnerability exists while the opposite case suggests the potential for outperformance.

 


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