Trader’s Narrative

A very old indicator that measures the magnitude of speculation on Wall St. is the volume ratio between the NYSE and the OTC market. This ratio hearkens from the early days when Nasdaq was the over the counter market where smaller and riskier securities traded.

This was before the time of Microsoft (MSFT) and Intel (INTC) - bellwethers of both the stock market and the US economy. Today it would be more apt to substitute the Pink Sheets OTC BB market instead.

Even so, for some reason the volume ratio still holds and has flagged important market tops. Including the start of the bear market in October 2007.

There is no absolute level however in this ratio that can give us oversold and overbought readings. As with all analysis of volume, we have to contend with not only a seasonal pattern, but also a continuous increase of trading over time. Since we are looking at a ratio, most of the upward creep in volume should be canceled out.

Right now, the volume ratio is extremely high and points to a lot of froth in the market. We’ve seen other signs of this in the sentiment data as well.

To play devil’s advocate, the ratio could be higher because of the Nasdaq’s leadership (it has rallied much more than the NYSE since March 2009).

Measuring the volume ratio of the Nasdaq and the NYSE goes back to the early days of technical analysis.

At its genesis, the Nasdaq was seen as a lesser exchange where smaller, younger and riskier companies who had yet to prove themselves got listed. The NYSE on the other hand was where these companies all wanted to be one day… if they met the listing requirements.

Advancements in technology have made such impressions anachronisms as the Nasdaq has become the “big board” for innovative companies in software, hardware and biotech.

While the image of the Nasdaq as a lesser stock exchange may been lost, the merit of comparing the two exchanges volume remains.

As you can see, during times of great market stress; when fear and loathing has gripped everyone’s imagination, the ratio is lopsided with the Nasdaq having relatively little trading compared to the NYSE. The end of 2002 and the first few months of 2003 are a good example:

The logical explanation offered is that people gravitate towards the NYSE in times of heightened risk because it contains well established companies.

The latest spike low - reaching almost parity - came on March 20th, 2008, which surprisingly was after the sharp declines. While a spike low is intriguing, it is not the same as a resetting of the volume ratio to a lower handle.

But then again, that would dovetail with the theory that what we are seeing is not a bear market bottom or a bear market at all but rather a very brutal correction within a cyclical bull market.

The previous time I mentioned the Nasdaq to NYSE volume ratio, it had just signalled (correctly) that October 2007 brought with it a very high probability of a top.