Price-volume relationship in the Brazilian market, stock lending and technical analysis/Relacao entre preco e volume de negocios, emprestimo de acoes e analise tecnica.
| Autor | Sanvicente, Antonio Zoratto |
| Cargo | Texto en ingles - Ensayo |
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Introduction
According to Blume et al. (1994), technical analysts believe that both price and volume data signal future price movements. Hence, the examination of both price and volume data would be useful to improving knowledge of return fundamentals. "If markets are efficient in the sense that the current price impounds all information, then such activity [technical analysis] is clearly pointless. But if the process by which prices adjust to information is not immediate, then market statistics [such as trading volume] may impound information that is not yet incorporated into the current market price. In particular, volume may be informative about the process of security returns." (BLUME et al., 1994, p. 153)
The present paper examines the relationship between price and volume series in the Brazilian stock market, by first testing the so-called "V-shaped relationship" theoretically developed by Karpoff (1987) and identified in several empirical papers for the U.S. market. (1) That relationship is expressed by the existence of a positive covariance between volume statistics, usually measured by turnover--that is, the ratio between, say, daily financial trading volume and the total market value of a firm's equity--and the absolute value of that equity's price change in the same period. That evidence clearly contradicts the implication from market efficiency: current price would not impound all information.
The paper also considers additional information that may be provided by activity in the Brazilian stock lending market, as a determinant of trading activity in the spot stock market. Borrowers of stocks use this market for two main purposes: (a) getting hold of securities to be delivered as a result of previous borrowings; (b) short selling in order to benefit from stock price declines, in isolation or as part of long-short, arbitrage strategies.
A previous study for the Brazilian market was Saatcioglu and Starks (1998), but it used a stock market index instead of individual stocks, as is done here, allowing us to associate the intensity of the V-shaped volume-price change relationship with certain security characteristics. Stocks of forty-seven different issuing companies are examined in this paper. Another important difference is their use of monthly data, instead of daily data, and for a period that pre-existed the operation of the stock lending market in Brazil.
Hence, this paper also adds to the international literature by assessing the impact of the lending market segment on the strength of the V-shaped relationship between spot market trading activity and spot market price changes, and is also one of the first papers on the Brazilian market to make use of lending market data.
The remainder of this paper is structured as follows: section II reviews the relevant literature, from Karpoff (1987) on, and including papers that consider a role for securities lending in the determination of equity market prices. Section III presents the main hypotheses being tested, while section IV provides details on the variables and the sources of data used. Section V then explains the methodology used for hypothesis testing, section VI provides the results and section VII concludes.
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Review of literature
2.1. The relevance of market volume in technical analysis
Users of tools of technical analysis in the development of trading strategies contend that volume or a similar market trading statistic supports the inferences drawn from price behavior: "The odds increase that a technical signal is correct if there is confirmation from another unrelated indicator. In the days when only chart patterns were available as a means of interpreting price action, the technical analyst uses volume as the confirming indicator." (KIRKPATRICK & DAHLQUIST, 2007, p. 411)
The same authors also refer to a much older technical analysis handbook (GARTLEY, 1935), in which the following general rules were enunciated for how to interpret a change in volume (among others): (1) when prices are rising, volume increasing is impressive, but volume decreasing is questionable; (2) when prices are declining, volume increase is impressive, but volume decreasing is questionable. Hence, price changes would have to be "confirmed" by volume. In addition, "when a price advance halts with high volume, it is potentially a top [but] when a price decline halts with high volume, it is potentially a bottom." (KIRKPATRICK & DAHLQUIST, 2007, P. 416.
As explained in Bodie et al. (2014), if prices respond slowly enough to new, fundamental information, the price adjustment period would be take the form of a sluggish response of prices to fundamental supply-and-demand factors (p. 354-355). Therefore, price changes could be attributed to changes in the volume of trading, i.e., the current information on quantities bought and sold.
As further support for the potential information content of volume data, a well-known technical analysis manual, when summarizing so-called "tactical methods", recommends, among other procedures, to get out of present commitments on "one-day reversal if marked by heavy volume" (EDWARDS & MAGEE, 1998, p. 507), or to make new commitments "on Flags and Pennants, after sufficient Secondary or Corrective Move by the pattern, or (possibly) within the pattern, provided that volume and all other indications tend strongly to confirm the pattern." (EDWARDS & MAGEE, 1998, p. 508)
Hence, it seems clear that technical analysis is predicated on a belief in the existence of some information content in volume statistics. In the next two sections, an appeal to modern finance theory arguments and models is made to provide additional support to that belief.
2.2. On the volume-price change relationship without a limited role for stock borrowing and lending
In a survey of the then existing literature, both theoretical and empirical, Karpoff (1987) developed explanations for the observed relationships of stock market turnover with both the magnitude (i.e., the absolute value) of contemporaneous returns, and also with signed returns.
In addition to his own specific modeling in that paper, the author appealed to two well-known market adages: (2)
(a) Volume is high in bullish markets, low in bearish markets; this would be consistent with positive covariance between volume (turnover) and signed returns, represented by [DELTA]p.
(b) It takes volume to change prices, in any direction; this would be consistent, if true, with positive covariance between volume (turnover) and the magnitude of returns, represented by the absolute value of [DELTA]p, or [absolute value of ([DELTA]p)].
The argument had to do with the association of volume and price with information flows in a sequential information arrival process, where information dissemination is gradual.
In Copeland's (1976) basic model, information is disseminated one trader at a time. With Ntraders, suppose k are optimists, r are pessimists, and N--k--r are uninformed investors, at any time before all N investors become informed. Short sales are assumed to be prohibited. (3) Therefore, the trading activity generated by a pessimist is usually lower than that generated by an optimistic investor. Hence, price change and trading volume when the next trader becomes informed depend on (a) the preceding sequence of who has been informed and (b) whether the next trader is optimistic or pessimistic. In a similar fashion, total volume after everybody has been informed depends on the path by which the final market equilibrium is reached. It then becomes a random variable, and simulation indicated that volume is highest when investors are all optimists or all pessimists; in addition, that the absolute price change is lowest at the same percentage of optimists at which volume is lowest, and that it rises with volume, and this evidently supports a...
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