Low Volume? No Problem.

If you stick to bigger names, you'll be fine

   

Low Volume? No Problem.

It’s summertime. The kids are out of school, the beach is calling and traders are starting to worry because volume is drying up on Wall Street, right? Well, yes and no.

It’s true that volume does tend to decline during the summer months, but it’s not quite as concerning as many financial news outlets and commentators would lead you to believe.

Let’s start by looking at why traders care about volume levels on Wall Street.

Why Volume Matters

Low volume indicates lower liquidity, which can lead to increased volatility. This is especially true for stocks that already suffer from lower levels of liquidity due to their nature as smaller stocks — we’re talking about small-cap stocks and penny stocks. While increased volatility can provide additional trading opportunities, it also exposes traders to additional risk. A stock that could see a large jump to the upside is also vulnerable to a large drop to the downside.

Increased liquidity typically reduces volatility because it brings more buyers and sellers together who might be willing to trade at price levels in between the bullish and bearish extremes.

Knowing that increased volume, which leads to increased liquidity, is typically a good thing, let’s next take a look at the data. What happens to volume during the summer?

Volume Data

For this analysis, we looked at the total number of shares that traded on the New York Stock Exchange each month from 2010 through the present. As you can see in the NYSE volume comparison chart in Figure 1, volume does seem to decline from June to August — excepting 2011, when the market plunged after the U.S. Congress flirted too closely with default amid the debt ceiling debate.

market volume2 Low Volume? No Problem.

Figure 1 – New York Stock Exchange (NYSE) Monthly Volume Data

However, while summer volume is somewhat lower than late-winter and spring volume, volume seems to remain lower through the fall and into winter … yet nobody seems to stoke fears that a low-volume environment is going to derail trading during the latter months of the year.

General Volume Levels

The other phenomenon you probably noticed in Figure 1 is volume in general has been dropping each year since 2010. While on the surface this may look incredibly concerning if you are worried about decreased liquidity, there is an explanation: The volume is still in the market, it’s just in dark pools.

Dark pools are private exchanges where traders can buy and sell shares while remaining anonymous. Whether or not you like the concept of dark pools, they are very much a vibrant part of the U.S. stock market, and they are garnering an increasing amount of business.

The Financial Industry Regulatory Authority (FINRA) just started to gather and publicly disseminate the weekly volume data from these dark pools. In Figure 2, you can see the volume data for the week of May 12, 2014, for the top 10 of 42 dark pools being reported on by FINRA.

dark pools Low Volume? No Problem.

Figure 2 – Weekly Trading Volume in Dark Pools (source FINRA.org)

If you were to take the total weekly volume reported by these dark pools for the week of May 12 and multiply it by four weeks, you would get a monthly total of about 12.4 billion shares traded in dark pools. That’s quite a bit of volume.

Conclusion

If you are trading small-cap or penny stocks and are already concerned about a lack of liquidity, the decreased volume we typically see during the summer months may exacerbate the risk you are already facing. However, if you are trading stocks that typically have plenty of liquidity, lower volume this summer probably isn’t going to have too much of an impact on your trading.


Article printed from InvestorPlace Media, http://investorplace.com/2014/07/low-volume-problem/.

©2014 InvestorPlace Media, LLC

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