Should Investors Be Worried About Volume?

by Daniel Putnam | July 15, 2011 5:29 am

Stock investors can be forgiven for feeling a little bit lonely these days.

Trading volume, which has lagged in the wake of the financial crisis, appears to have taken another leg down — and not just because it’s summer. According to Barclays Capital, last week saw volume dip 23% compared to the same time a year earlier. What’s more, exchanges are showing across-the-board declines for the full year thus far.

At first glance, this makes sense. Many investors were burned by the market downturn of 2008-2009 and the flash crash last May, and the uncertainty created by the European debt crisis and U.S. budget battle isn’t exactly prompting a stampede back into equities.

The collapse in volume becomes even more curious when you consider the growth of high-frequency trading (HFT). Depending on what source you use, HFT makes up anywhere from 55% to 75% of the stock market’s daily volume. With overall volume dropping and HFT on the rise, that points to much lower volume from traditional investors.

The issue of lower trading volume has received a great deal of attention. Traditional technical analysis tells us that the combination of rising price and falling volume points to a low-conviction rally — and one that is destined to end badly. Expect to hear more on this subject in the weeks ahead, since this is the time of year when volume typically hits the doldrums.

So is it time to start worrying? The short answer is no. There are two obvious — but instructive — points to keep in mind. First, volume has been on the wane for two years now, but this is based on a comparison to the peak volume years of the financial crisis — a period of severe trauma for the markets. On an absolute basis, volume is at about the same level as it was four years ago. Second, during the time in which volume has been falling, the market has been rising steadily. Investors who paid too much attention to volume cues in the past two years would have missed out on a major rally.

For those who want to see more robust trading volume, be careful what you wish for. Any meaningful pick-up in trading activity at this time of year will accompany a selloff rather than a rally. If you wait for higher volume as a buy signal, you might be getting in at just the wrong time.

The bottom line: Volume is certainly an important indicator when it comes to individual stocks, but its recent track record when it comes to the broader market is iffy at best. Investors would be well-served to keep their eye on prices first and only pay peripheral attention to volume — especially during the summer.


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