Can The Market Bottom On Light Volume?

One common misconception about steep selloffs is that they need to be accompanied by high volume in order to mark a bottom. October 10th and (to a lesser degree) November 20th, 2008 are two examples of big down days that came on big volume that soon led to a reversal. While this pattern can precede a bounce, you’d much rather see your new low accompanied by very low volume than very high volume.

Let’s look at some studies to illustrate this claim. First let’s look at performance following a 50-day low that has neither very high nor very low volume: {edit: the following tests were inadvertently run from 1992 - present, not 1960 - present. See March 10th follow-up blog for more details and longer-term results.}

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So this is the base case and as you can see there is a slight upside edge over the next 1-20 days.

Now let’s look at the ever-popular high volume selloff:

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Results here are nearly indistinguishable from the base case. The high volume, while not a deterrent, does not seem to provide an additional edge.

Now let’s look at the less common case of a 50-day low occurring on light volume:

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While the number of instances is less than desired these results are clearly superior to the other scenarios. Over 90% winners after both 4 days and once you get out over 3 weeks. The average trade over the next week and over the next 4 weeks is about 4 times the size of the base case. While they didn’t all mark the exact low, some success stories included 10/7/02, 3/10/03, and 1/24/05.

There are plenty of technical reasons we should see a strong rebound soon. Thursday’s light volume can be added to the list. Now let’s just hope the market stops ignoring these reasons.