Don’t Fret About Weak Trading Volume

When it comes to the broader market, share volume tells us little

   

If you think trading volume has been weak in the past month, just wait: August is upon us, which means we’re entering one of the dullest periods of the year.

As it is, share volume has already been in the doldrums. Using the S&P 500 as a gauge, average daily trading volume in July is off 12% from July 2012, which in turn was 14% below the average registered in 2011. In fact, July volume has steadily trended lower since the 2008 bear market, mirroring full-year trends.

This has been a cause of concern, since the conventional wisdom says the combination of rising price and falling volume is indicative of a low-conviction rally.

But does it matter?

Not necessarily. The first (and most obvious) reason is that declining trading volume has been occurring for five years now — a time during which the market has been delivering average annual returns north of 15%. Investors who paid too much attention to volume cues during the past two years would have missed out on a major rally.

This illustrates another trend: Namely, that high volume and down markets have gone hand-in-hand in recent years. Last week, CNBC cited work from Bespoke Investment Group showing that since March 2009, “below-average days for volume yielded market gains of 296 percent, while above-average days saw losses of 37 percent.”

This is, in a nutshell, the most telling evidence that lower trading volumes shouldn’t be a cause for concern.

Also, it’s important to keep in mind that dollar volume — as opposed to share volume — has remained relatively steady in recent years. A look at the statistics on SIMFA’s website shows that total dollar volume averaged $118.8 billion per month in the first half of the year, slightly ahead of the $118.5 billion registered in the same time period last year. While dollar volume has slipped from where it stood in 2010-11, the drop-off is actually much less than share volume data would indicate.

This makes perfect sense, given the rising stock prices of recent years: $10,000 invested in Google (GOOG) with the price near $900 today creates lower share volume than it would have when the stock was in the $300s four years ago. On the other side of that same equation, volume naturally had a bias toward the high side in 2009-10, when stocks were coming off two years of being pummeled in the wake of the financial crisis.

Finally, absent the impact of surprising headlines, don’t expect trading volume to pick up any time soon, since the second half is traditionally a slower time of year for volume. This stems not only from the impact of summer trading and the various holidays that occur in the fourth quarter, but also from the reduced impact of IRA contributions and the investment of bonus payments that fuel higher volume in the first four months of each year.

The Bottom Line

Those who are hoping for a pickup in trading activity should be careful what they wish for. A surge in share volume — particularly in the summer — will almost assuredly accompany a selloff rather than a rally.

Trading volume can be a highly useful indicator for analyzing the direction of individual stocks, but its track record as a broader-market indicator has been questionable for some time. Investors would be better off watching prices first and de-emphasizing the importance of volume, especially as we enter the dog days of August.

As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, http://investorplace.com/2013/07/dont-fret-about-weak-trading-volume/.

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