Friday's Market Action: Parabolic Move on No Volume

by: Toro

I'm not a technician, but one lesson I have learned is to not trust big moves on light volume. That does not mean big moves on light volume cannot be followed by big moves on heavy volume. However, the odds are that big moves on light volume are subject to reverse, and sharp ones at that.

Consider the first week of October. The average daily volume on the New York Stock Exchange for the past week was 1.188 billion, the second lightest of the year. Only the July 4th week was lighter, with daily average volume at 1.136 billion shares. And July 4th fell on a Wednesday, with much of Wall Street taking a four-day weekend before or after Independence Day.

There have been 192 trading days so far in 2007. Thursday was the second lightest of the year at 1.042 million shares. Wednesday was the 10th lightest volume day, Friday was the 11th lightest, and Tuesday the 13th lightest. So while the cheerleaders on Bubblevision gush over the markets new highs, the light volume should give investors and traders pause.

Next consider that since the lows on August 16th, the S&P 500 has risen 13.6% into Friday's close. By coincidence, that represents 50-trading days. Since the bull market began on October 10, 2002, there have been only two other occasions when the market has moved as fast over 50 trading days - off the bottom into November 2002, and March/April 2003.

In fact, if you look at a logarithmic graph of the market (which, unfortunately, I am unable to show here), you will see six distinctive upward legs. The the biggest moves upwards (i.e. steepest slopes) occurred at the end of 2002 and into 2003, which is normal at the beginning of a new bull. The next upward leg began in Spring 2003 and lasted for a year. The slope of that ascent was less steep.

The market moved sideways for much of 2004 before moving up again into Spring 2006 at a much more methodical pace. Then, from August 2006 to February 2007, the slope of the market started shifting higher. After the market cracked in March, we rebounded and the bounce was sharper. Then, after the sell-off in July and August, the most recent bounce has been the sharpest since the moves off the bottom at beginning of the bull market.

This is emblematic of how bull markets often run. At the beginning, the market bounces hard off the bottom as the selling exhausts itself. At first, the move up is met with disbelief. Then, as the upward move continues, investors become more comfortable putting money to work. As the bull market ages, and investors become more confident that nothing can stop the bull, they keep buying at higher and higher prices. The final move upwards is often parabolic as investors panic that they will be left behind and throw money at the market almost without regard.

This is what may be occurring now.

Of course, the action of the past five years does not necessarily preclude anything. The market is going to do what the market is going to do. Maybe we are going to go up for the next five years, I don't know. But this period reminds me a lot of 1998 and 1999, after the Fed cut rates to alleviate problems in the fixed income markets. And you know what happened then.

If that is the playbook, a cathartic, blow-off top is coming. If so, sell the rallies.