I’m about to go out for a while, but I thought I’d leave you with a quick thought. Maybe everyone knows this, and maybe not. It’s conventional wisdom that you want to see low-volume pullbacks on trends. They are safer to jump into. Do you know why? If not, think about and make a guess before reading on. Or don’t; I don’t really care. I just like to say that stuff because it makes me sound more educational.

Ready? Let’s take an uptrend, for our example. So, you start with move up in the stock price. There are two ways this can happen (I’m oversimplifying): strong buyers, or weak sellers. You want the up move to be on high volume, because that indicates that it’s likely that you have strong buyers.

Now, the pullback. The stock price is moving down (or at least, not moving up anymore). There are two ways this can happen: strong sellers or weak buyers. Low volume during the pullback makes it more likely that you have weak buyers. And, when you think about it, that’s the preferable option if you hope that the trend will resume. This is also why you want the pullback to be relatively shallow: you want the buyers to be resting… not absent!

An “ideal” uptrend has surges of buying pressure with rests in between, and no big surges of selling pressure. In fact, books on chart patterns sometimes say that a prolonged increase in volume often indicates the end of an uptrend. I imagine one reason could be that sellers step up and eat through the remaining buyers, causing a glut of volume at the top. Another reason would be if the volume surge corresponded to a parabolic move up, which is unsustainable in most cases. Yet another reason would be that a glut of volume means a lot of people are holding shares, and the market always tries to screw over as many people as possible.

Think of that last reason for a minute, and realize why increasing volume does not point to the end of a down trend as reliably as it indicates the end of an uptrend. A prolonged increase in volume means a lot of people are long the stock. For the market to screw over the most people, it would need to continue dropping a bit longer, and then snap back up on lower volume.

So, there. I think it helps me a lot to have an understanding of what might be going on “inside” the chart. I prefer to think I’m trading real market phenomena, and not just chart patterns.

I see a lot of references out on the web about how seeing block trades–especially at the ask–is a good sign for going long. But, without a vigorous trade rate to back it up, it’s not so!

Today, I was stalking FIS to go long above 48, and I saw a 140,000 share print go by. At the time, that doubled the total volume for the day. So, I should hop right in, right? Especially if the trade is at the ask, right? In this case, not at all! Trades were not going off fast and furious in the wake of the big print.

It’s a Matter of Market Mechanics

Note: This is just my conjecture about what is happening, but it makes sense to me. Regardless, it’s the end result that matters, and I’ve seen it plenty of times. Of course, the markets rarely act 100% like you think they logically should. That can make things difficult, but I still love women all the same. Markets, I mean. Love the markets all the same. :-)

So, what happens when a very large buy order comes in (a size much larger than the typical ask for a given stock)? The market wouldn’t be very orderly if the Specialist let it just eat through ask levels. Instead, they supply the needed liquidity by selling their own reserve shares to the buyer. What’s important here is that now our market maker effectively has a large short position on. Which direction do you think he wants the stock to go, then? Down, that’s where! I imagine the market maker will do whatever is in his power to keep the stock down until he can buy back the majority of that position at a lower price. The hybrid market must make that harder for the NYSE specialists to do, but they still have influence.

In today’s FIS case, I noted the volume at the block print (the one just before 10am). I decided that the next unhindered push at 48 would only happen after 150k to 200k more shares had traded. In fact, that’s exactly what happened… when the stock pushed to 48 again around noon. Of course, that push failed, too, and I lost interest in the stock and went to sleep.

What If Demand Is Too Great?

Now, consider the case where the Specialist fills the block order, and there is so much demand that he can’t easily keep the stock down. Many small and medium size buyers are piling on left and right, and prints are going off quickly. Now, the specialist will eventually have to give in and buy back the shares he had provided at a loss. Not only does this alleviate the downward pressure he would otherwise apply, but it actually helps fuel the run up!

That’s why I say you need to have energetic small-timers buying at the time of the big block trades, for them to do you any good. If the other buyers are standing aside, whoever just made the market for that block buyer will certainly push the stock down to make some easy money.

The Logic Works in Reverse, Too

If a big block goes by at the bid, then there must have been a large seller. Bearish sign, right? Just reverse the logic, to see that we may now have a greedy market maker with a large long position. They will try to prop the stock up long enough to sell those shares at a higher price.