Adrian Reid explains why moving average volume fails as a liquidity filter for small-cap stocks. A single announcement can spike volume so high that the average stays inflated for weeks, masking days with almost no trading. Switching to median turnover instead fixes the problem.
If your trading system generates signals that pass your liquidity filter but give you terrible slippage and wide spreads, this one trick is probably going to save you.
Most of our systems have a moving average of close times volume as the turnover, and it has to be above a certain level. Doing an average on very low liquidity stocks sometimes is not ideal because if like a small cap miner, for example, they might have an announcement, they might strike gold or whatever. Then they have a huge volume spike on one day or over a couple of days. And then either side of that, there's basically no volume. That huge volume spike can cause it to pass the liquidity filter for quite a while, even though it's not actually that liquid. So if you've got a system where you're finding that you're getting a lot of slippage, have a look at why the stocks are passing the liquidity requirement and decide whether or not there's a different liquidity requirement formula that might work better. For example, in that case, maybe you would use median turnover instead of average turnover because it'd be less impacted by an extreme volume spike.
This simple shift can make all the difference when you're trading on low liquidity stocks that are prone to volume spikes like resources and mining stocks. If you want more trading tips from Enlightened Stock Trading, make sure you give this video a like and follow Enlightened Stock Trading so you don't miss the next video. And go to enlightenedstocktrading.com/free to get your free Trader Acceleration Bundle to start improving your trading results today.
