On Balance Volume Signing Major Market Warning For Months Ahead

By Christopher Diodato

Normally, my analysis is focused on short-term, exact predictions, but not in this post.  Ever since the August 2011 mini-panic, pundits have been calling for a new bear market.  Obviously, they were early, but we cannot dismiss the importance of this decline, even over a year later.  During that decline, the market printed some of the highest negative weekly volumes since fall of 2008.  During that nervous August, the influx in selling volume indicated an enormous rise in selling pressure in the market.  Those same measures of selling pressures, not recovered from the August collapse, are still telling investors to be cautious.

The chart below shows weekly data of the S & P 500 ETF with the On-Balance Volume (OBV) study on the lower graph.  The OBV is calculated by adding the index’s total weekly volume if the index’s price finishes higher and subtracting if it falls.

Generally, the market OBV will top before the actual index does.  This is typical.  In idealized Wyckoff market top, a high volume downward correction is very common before the market makes its final high.  That high volume correction drives the OBV down so much that the measure cannot make new highs.  That is our warning.  Similar warnings were issued before the 2000 and 2007 market tops.

In addition to the OBV divergence, note the actual volume statistics.  Since 2009, the market has been trending upward.  However, volume has been consistently falling, especially on rallies.  In fact, as the market rallied in August, some of the lowest trading volumes in years were recorded.  Then, a glance at shorter term charts shows that volume has been increasing on declines and decreasing on rallies.  In short, the demand that has been propping up the market is stalling out.

Frequent readers know my opinion.  One more rally, then head for the emergency exit.

Happy trading!

~Chris Diodato