14 – M4 L1B 15 Volume Factors V1

Volume-based factors usually include price information, to categorize the volume in a given time period as a net buy or net sell. At first glance, the idea of net buying or net selling, may appear counterintuitive when you recall, that every transaction involves a buyer and a seller. Some examples will help to clarify what we mean by this. A volume factor may track whether the total trading volume of a stock is higher than normal, and use that to determine whether recent price movements are significant or not. For example, sometimes stock exchanges are open on or around a major holiday, and since fewer investors are participating in trading, volume may be lower on these days. So investors will take the low volume into consideration, when deciding whether price movements are significant or not. Volume can help add more context to a price-based factor, such as a moment factor. For instance, unusually high volumes that accompanies a major price movement, may be a sign that the momentum signal is more significant than usual. One could say that the price-based momentum factor, is conditioned on the volume information. One piece of volume data that is independent of price is called short interest. Short interest tracks the quantity of a stock shares, which are held short. When a trader shorts a stock, they borrow the stock from its owner and sell it, with a hope of buying the stock back at a later date when it’s cheaper. If instead, the stock price increases, the short seller will realize mark to market losses. Mark to market is an accounting concept, that assess the value of a health asset at its market price. So mark to market losses, are unrealized losses that are tracked in accounting, even if the asset isn’t sold to realize those losses. This can become expensive if the stock price keeps rising, so short-sellers may decide to cut their losses, by buying the stock at the market price, and closing out their position. This is called a short squeeze. If this sounds a bit complicated, consider the mirror image of a short squeeze, which is a long squeeze. If you bought stock in a retail company, and watch the stock price decline day after day, you might have decided at some point to cut your losses and sell the stock. This long squeeze is the mirror image of a short squeeze. When a short squeeze occurs due to an upward price movement, the additional stock buying that it triggers, tends to add more upward momentum to the stock price. So if recent short interests is higher than usual, this might be considered a buy signal. Since an increase in price, may trigger a domino effect of additional increases. This could motivate a nice Alpha factor. Find stocks that have high price momentum, and are highly shorted. In this case, short interest data could act as a conditioning information, to make a momentum signal stronger.

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