My Trading Licks

I’ve recently discovered baking bread to be one of life’s great pleasures. And while waiting for the dough to rise, I’ve also started testing some new trading strategies, one of which is an on volume method for shorting the S&P 500. Between baking bread and shorting the market, I must say one is a heck of a lot easier than the other.

Of course some folks would say that with proper diligence, making money going short is no problem. And while I can certainly see their point, thinking of the constant stress I once put myself through to make such trades, a famous Warren Buffet quote comes to mind… “If you don’t find a way to make money while you sleep, you will work until you die.”

For almost 8 years now, I’ve been on a quest to profit from the stock market while I’m off baking bread or doing whatever else I enjoy doing. Trading on volume has allowed me to create an automated system to do just that, without staring into screens all day, keeping stress levels in check and getting a good night’s sleep in the process.

The TVO system strategies are all firmly rooted in the long side, but why is it that equally effective strategies on the short side are so hard to develop? Well, for one thing, volume can be a double edged sword. Market technicians will often say that high volume accompanying a move confirms the direction and continuity of that move, however, depending on the context, this can just as easily go the other way. Just as often, we see the market drop on heavy volume, and before the shorts can even think about opening a position, the market reverses direction.

Case in point, last Friday and Monday were heavy distribution days where volume jumped over 10%. One would expect the downward move to continue, however, that notion was met with today’s face ripping rally on a 20% drop in volume.

But wait… why does volume drop on the day of the reversal? Doesn’t that negate the validity of the move? Well, not really, because heavy volume was ALREADY THERE before the start of today’s session. If you can think of volume as a leading indicator, it’s not so hard to grasp that it can affect market internals well before they make themselves known in the price. You could say it’s baked in, if you will.

How do we know that heavy down volume is the end of the move and not just a precursor of what’s to come? The truth is, we don’t really know, but TVO has a pretty good idea. The day before the rally, as a result of Tuesday’s session data, our volume oscillator reversed towards positive values, indicating that sentiment had already shifted according to volume and market internals.

Does TVO know if the move will continue? It’s only right at predicting price reversals about 75% of the time, but that’s enough for us take controlled risks on the long side. In the meantime, if I can come up an equally effective (and easy) way of using volume to go short, you’ll be the first to know. For now, though, I’m leaning towards putting more time into perfecting my baking skills. – MD

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