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After surging 11.9%
higher in just 7 trading days, the flagship HUI gold-stock index is starting
to recapture traders’ attention. Right as this rally launched a couple
weeks ago, I pointed out this sector’s exceedingly bullish technicals. Since then, I’ve been
examining secondary indicators including volume to see if they corroborate
the key primary ones.
Trading volume, the
number of shares changing hands in a given day, offers a valuable window into
the ethereal realm of prevailing sentiment. When traders are complacent and
bored, volume dwindles. Few get excited about trading lethargic stocks. But
when emotions run high, volume often spikes dramatically. This is the case
whether traders are suffering from excessive greed or fear. Volume surges
when traders get excited, for any reason, and want to trade more.
Precious-metals-stock
traders can capitalize on these volume tendencies to help fine tune our entry
and exit points. Big volume spikes, depending on where they occur within
prevailing short-term trends, can signal various important trading
milestones. These include the launch days of big and fast rallies, the births
of major corrections, and the capitulation episodes signaling the ends of
these corrections.
For speculators and
investors alike, no technical events are more important to discern than the
major short-term reversals. These critical transitions from upleg to
correction and vice versa mark the exact moments when it is most advantageous
to buy low or sell high. Volume spikes, while being too ambiguous to be primary
indicators, offer excellent secondary confirmations of major reversals.
Unfortunately in the
HUI’s case, this volume analysis isn’t easy. Despite gold
stocks’ spectacular 1331% gains over a 7-year span where the general
stock markets lost
7%, gold stocks still get no respect. As a neglected and highly-contrarian
sector even this far into its secular bull, the HUI doesn’t actually
trade. It is merely a tracking index, so there is no conventional
index-futures volume data available to analyze.
Working around this
limitation is possible using HUI composite
volume. Today the HUI gold-stock index is comprised of 16
individual-stock components. By adding together
the individual trading volumes of all these component stocks, we get a
composite of HUI volume as a whole. While technically easy to do, this task
is still data-intensive and requires plenty of spreadsheet time. Thus HUI
volume isn’t analyzed often.
While I’ve
analyzed HUI composite
volume
in the past, trading it requires delineating between normal and exceptional
activity. Defining volume spikes as exceptional in real-time is only possible
if there is some baseline from which to make these judgments. The raw
composite-volume data is so wildly volatile that it is hard to recognize
significant volume events out of the incessant cacophony of background noise.
As I’ve pondered
this puzzle lately, I came up with a couple ideas for solutions. HUI capital volume is
fairly conventional, while HUI relative
volume is an entirely new construct. Together they work to
identify exceptional volume spikes in real-time to use as secondary
confirmations of primary trading indicators. While I examined nearly a
decade of this data in doing my research, I’m limiting this
essay’s discussion to this past year to keep it a manageable length.
While conventional
volume looks at shares changing hands, capital volume looks at the actual capital
being traded. This distinction is important. Imagine two stocks, each doing
1m shares today. They’d naturally have equal impact in
conventional volume analysis. But what if one is trading at $3 and the other
at $30? While their raw volumes are equal, 10x more capital changed hands in the
second. Therefore it is far more important. Capital volume is a much purer
measure of actual trading activity.
This first chart looks
at daily HUI capital volume over the past year. Capital volumes for all
individual HUI component stocks are computed daily and then added together.
Since actual capital changing hands is far more important than the raw shares
traded, this perspective helps exceptional volume spikes stand out more
boldly. These spikes tend to correspond with several very specific tradable
events.
The three primary types
of exceptional volume spikes are capitulation spikes, early-rally spikes, and
initial-selloff spikes. Capitulation spikes occur late in ongoing corrections
when frustrated traders trying to ride out the selling finally surrender and
sell in disgust. These are fear-driven events that coincide with big down
days late in corrections. My initial motivation to do this research was to see
if February 4th’s 5.9% HUI selloff to a new interim low qualified as a
correction-ending capitulation spike.
It kind of did. 146m
shares of HUI-component stocks changed hands that day, worth $3.0b. That
selloff marked the biggest raw-volume and capital-volume day in a couple
weeks. Back on January 21st, a mid-correction 4.4% down day, the HUI traded
156m shares worth $3.8b. In general, the bigger the capitulation volume spike
the more fear and hence the better the buying opportunity. So although
I’d hoped to see a bigger spike on February 4th, that event still fit
the capitulation-spike mold.
Capitulation spikes
mark the critical transitions between major corrections and major uplegs.
Obviously speculators and investors alike want to aggressively add long positions
whenever a correction is reversing into a new upleg. We’ve been doing
this at Zeal recently, aggressively buying and recommending elite gold and
silver stocks in our popular subscription newsletters. This wasn’t
because of volume though, which is only a secondary confirmation. The primary
buy signals were the HUI
technicals
and the HUI/Gold
Ratio.
Interestingly the day
after this capitulation spike (February 5th) was a more meaningful volume
spike, and brings us to the second type. It is an early-rally
spike. That day the HUI surged 5.3% higher which started getting
traders excited about gold stocks again. They bought aggressively, pushing
through 168m shares worth $3.8b in capital terms. Early-rally spikes,
as you can see in this chart, tend to happen early in big rallies. They are
clear signals that sentiment is turning bullish again, that buyers are
flocking back in.
The third type of
exceptional volume spike is the initial-selloff spike. We last saw one in
early December just after the HUI’s latest upleg topped. On December
4th the HUI plunged 5.2% thanks to a steep 4.1% gold selloff (driven by a
sharp US dollar
rally).
That day a staggering 207m shares of HUI-component companies changed hands,
worth an all-time record $5.9b! Such heavy selling was a sign that the
upleg to that point had just rolled over.
Since exceptional
volume spikes occur more often than just at major upleg-to-correction and
correction-to-upleg transitions, we can’t rely on them as primary
trading indicators. As this chart reveals, even in capital-volume terms
it is not uncommon to see exceptional volume spikes in the middle of both
ongoing uplegs and corrections. But when you get an exceptional volume spike corresponding with
other primary technical signals, it really ramps up the odds that these
primary signals are correct.
Capitulation spikes
often mark the ends of major corrections, the point where the holdout traders
succumb to their fears and finally surrender at exactly the wrong time.
They help illuminate correction-to-upleg transitions in real-time.
Conversely, initial-selloff spikes often mark the ends of major uplegs.
Traders getting nervous about how fast and far gold stocks have run are quick
to jump on the first significant selling, and the resulting volume spike
betrays the end of the greed that drove the preceding upleg.
Interestingly both the
transitions from correction to upleg and upleg to correction are selling
events. The heavy volume occurs on large downside days driven by fear. But if the
HUI happens to be coming off a significant interim low, exceptional volume
spikes tend to happen on big up days. Heavy buying in early-rally spikes
signals the return of greed, a second chance to get long to ride the rest of
the upleg if you missed the primary buying opportunity at the end of the
preceding correction.
Gold-stock speculators
and investors alike would be well-served looking for these volume
spikes. If gold stocks have run higher for months without a significant
correction, and you see a high-volume selloff,
odds are it marks the end of that upleg. Greed was getting too excessive
so a rebalancing correction is necessary to rebalance sentiment. Large
high-volume selloffs just
after major interim highs are great secondary indicators that a
new correction is likely underway.
Conversely if gold
stocks have ground lower for many weeks or months without any meaningful
rallies, and you see a high-volume selloff, it likely signals the final
capitulation. Fear was getting out of control so a new rally needs to be born
to rebalance sentiment. Large high-volume selloffs leading to major interim lows
are a great secondary indicator suggesting the ongoing correction has finally
run its course.
A couple more points
before we move on. Note above that our latest correction since early December
has witnessed 4 separate exceptional volume spikes. We had the
initial-selloff one, a couple much smaller mid-correction ones, and the
latest a couple weeks ago which will probably prove to be the final
capitulation spike. Back in the HUI’s last correction in June and July,
we saw a similar pattern. As discussed a couple weeks ago, HUI corrections are often
two-staged. So late in a correction after two distinct legs down, the odds of
a big-volume down day being a capitulation spike increase considerably.
In
addition, check out the anemic capital volume during the summer months.
During the usual PM summer
doldrums in June, July,
and August, the HUI averaged just $1.5b worth of component shares changing
hands per day. Summer usually yields nothing but lethargy in the gold stocks,
so don’t expect much from them then. But once the busy autumn
trading season launches, volume returns. In September, October, and November,
HUI capital volume doubled to $3.0b per day.
While exceptional
capital-volume spikes corroborate other primary technical indicators at key
reversal points, there is still plenty of noise (volume spikes not
corresponding to major reversals) in this chart. So I decided to try a new
construct I’ve been wondering about, HUI relative volume. It looks at daily HUI
volume as a multiple of
its recent average. This is similar to the principles behind my Relativity
trading
system.
In order to define a
volume spike as exceptional,
we first have to define a baseline establishing normal. If I tell you I ate a couple
chocolate-chip cookies today, it is meaningless. Without knowing what I
normally eat, you can’t draw a conclusion. If I told you I
usually eat a dozen a day, you’d assume I went on a diet. If I told you
I usually eat one a month, you’d think I had a party. Context is essential for
interpreting data!
In conventional volume
analysis, the baseline average most often used is 3 months. With an average
month encompassing 21 trading days, this is essentially a 63-day moving
average. You Zeal subscribers have seen me compare exceptional days to this
average as a multiple
many times when analyzing individual stocks we are trading. I’ll
write something like “ABC stock rocketed higher that day on heavy
volume running 3.4x the 3m average”.
HUI relative volume
just extends this concept to chart form. Every trading day’s raw volume
is divided by the trailing 3-month average that day, which forms a baseline
“normal” level for that point in time. The resulting multiple,
charted over time, offers another complimentary perspective on what
constitutes an exceptional volume spike on any given day. The HUI
relative-volume multiple is shown in red below.
Note in this initial
analysis I used raw HUI volume, actual shares traded, not capital volume.
While we could certainly look at HUI relative capital volume, I didn’t
want to unduly complicate this new potential tool right out of the gates.
I’ll probably look at it some time in the future though and write
another essay on it if it proves interesting. But for now, this is based on
straight share volume.
While relative volume
reveals the same exceptional volume spikes we saw above in capital-volume
terms, it paints them in a different light. This perspective reorganizes
their magnitudes compared to each other, highlighting deviations from
prevailing norms instead of actual capital changing hands. While the biggest
capital-volume spike was in early December, the biggest relative-volume one
was in early September.
On September 3rd the
HUI rocketed 5.8% higher. The heavy buying resulted in a huge 202m-share day
($4.9b in capital volume). But emerging right after the slow market
summer, this early-rally spike ran a huge 2.9x normal volume. It was a
radical change compared to prevailing conditions to see such a massive volume
spike at that time. Meanwhile the December 4th initial-selloff spike saw
207m shares ($5.9b) change hands, but the 3-month average base at the time
was much higher so it was only a 1.7x relative spike.
Obviously in
relative-volume terms we can see the same three types of exceptional volume
spikes. There are initial-selloff spikes here marking the ends of uplegs,
capitulation spikes marking the ends of corrections, and early-rally spikes
signaling the return of greed-driven buying. Relative volume highlights the
importance of big deviations from prevailing norms in defining exceptional
volume spikes.
So which is superior as
a secondary trading indicator, capital or relative? I pondered this
question a lot this week as I analyzed a decade’s worth of both data
series. At this point my conclusion is neither is superior, they just offer
different perspectives. Capital volume reveals when big money is moving in
and out of gold stocks, a very valuable tool. And relative volume shows when
trading patterns change radically from their recent normal baseline.
It is probably best to
use these tools in concert, much like we do with the Relative HUI and HUI/Gold
Ratio as primary trading indicators. The higher both the capital volume
and relative volume in any given spike relative to recent precedent, the
greater the odds that spike marked an important trading event. Paying
attention to these HUI volume spikes increases traders’ odds of
recognizing critical short-term reversals transitioning between
upward-trending and downward-trending markets.
Just after major
interim highs these high-volume spike events signal the dawns of healthy
corrections, the time to sell longs and get short or neutral. And during
major interim lows these events mark the capitulations of mature corrections,
the time to add longs and close shorts. While only a secondary indicator, it
is always nice to have corroboration on primary ones. Watching volume spikes
can help you more efficiently buy low and sell high in real-time.
At Zeal we are lifelong
students of the markets, constantly looking for tools to increase our odds of
executing profitable trades. Over the recent weeks we’ve been
aggressively adding new positions in elite gold and silver stocks to ride the
next upleg. While the latest volume spike agrees with the primary indicators
in suggesting this upleg is already underway, it is not too late to get
deployed. Both gold and silver tend to have strong
seasonal rallies climaxing in May, which tend to drive big moves higher in PM
stocks.
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The bottom line is
paying attention to HUI volume spikes can really help traders fine-tune their
buy and sell timing. Volume surges when emotions run high, and sentiment
extremes mark the critical transitions between uplegs and corrections. So
when an exceptional volume spike occurs near or at a major interim high or
low, it is often a sign that a reversal is imminent or already underway.
But volume spikes can
be ambiguous, signaling different things in different circumstances, so they
are a secondary indicator. A volume spike alone doesn’t offer enough
information. It must be considered in context. Is it near a major interim
high or low? Was the HUI rising or falling, and for how long, prior to
the spike? And was the spike a greed-driven event on a big up day or a
fear-driven event on a big down day? With a little perspective, volume spikes
help traders identify key transitions in real-time.
Adam Hamilton,
CPA
Zealllc.com
January 15, 2010
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2006 Zeal Research (www.ZealLLC.com)
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