Reader Questions Answered

Thin holiday markets and new year volume pick-up

The following two questions came in from one of my newsletter subscribers in regards to comments I made about how the markets can trade around year-end and into the new year.

1. Regarding your 2000 EUR/JPY trade: I am wondering if your success with that trade was more a function of fundamentals than the low volatility of the holiday period. Everyone knows that there was a G7 coordinated campaign to prop up the Euro. Being both a position trader and a Forex analyst, it wouldn’t be a surprise if we were told that you considered that information in your decision. Lack of offers during the holiday period may have helped, but it’s hard to get a sharp move of thousands of pips without some fundamental development that the market perceives as a game changer.

In fact, I wasn’t actually working as an analyst at that point. I was coaching volleyball full time back then. My analysis was strictly technical in nature, which is what I tend to favor in my own forex trading in any case.

The point about there being a fundamental driver is a good one, as there is almost always something underlying a directional move in the market (though Wednesday’s trading demonstrates that it isn’t always the case for short-term moves), but it’s not an either/or thing. There is no doubt in my mind that reduced volumes around the holiday period helped to accelerate that rally for the simple reason that there weren’t sufficient offers on the other side to resist it. When the volume did start coming back in after the first of the year, there was a very sharp retracement, and in fact it wasn’t until a year later that the market was able to extend the late 2000 rally into the trend that eventually topped out in 2007.

2. You make it sound as if everything will be back to normal in terms of volume on January 3rd. I have noticed (and others have commented likewise) that the first two weeks of the year are similar to the last two in terms of liquidity. Is that definitely NOT the case in your experience?

Actually, if you look at stock market volume you’ll see it snaps back very quickly. For example, in 2010 the last two weeks of the year show 105mln and 76mln shares respectively (I’m looking at an S&P 500 chart – not total market volume). The first week of 2011, however, shows 197mln, which is basically in line with the volume peaks from normal period weeks before that. There’s a similar pattern looking back to prior years.

Note that volume and volatility aren’t necessarily the same thing. There are reasons why there’s increased volume flow in the markets to start the new year – reasons which contribute to the seasonal patterns which tend to be in force. And keep in mind that volume and participation isn’t necessarily the same thing either. Just because more money flows back into the markets (or through them), it doesn’t necessarily mean there are many more traders and investors active (though certainly it’s often the case).

By John

Author of The Essentials of Trading

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