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Opponents of this recent bull market will say that volume isn't as strong as in past rallies and therefore the current trend is weak and unstable. I found some interesting statistics and trends that might not only negate this theory, but give us a better understanding of who is actually driving these markets. You'll see that things are not what they may seem when it comes to current volume.
Volume is the Cause and Price is the Effect
Think of volume as a river's current flowing into or out of a stock or the stock market as a whole. If the current is strong in one direction, it can move prices quickly; if currents are opposing, then the water (stock) may not move at all.
Volume is created by transactions; when market takers (you, me and other investors) initiate an order to buy or sell, the "market makers" (liquidity providers) or other investors take the other side.
Dramatically diminishing volume in a short term up-trend might be a signal that there are fewer buyers at the moment, but it DOESN'T necessarily mean that the trend can't continue after a short break.
Also keep in mind that heavily traded and popular stocks have a ton of participants that help keep prices in check. Technical analysis (which almost always includes volume) and funds with computerized algorithms play a huge role in keeping stocks from getting too disconnected from the market.
The point here is that with so many eyeballs looking at stocks, abnormal price movements are being monitored whether the volume is high or low and if the stock is undeserving of its current value, markets generally "fix" it quickly.
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Recognize the Trends
Analyzing volume trends will help you see the real trend and determine if a certain movement in a stock is going to be carried through or quickly reversed. When you combine volume with fundamental analysis like the Zacks Rank and a quick glance at the techincals, your conviction and thesis will be that much stronger. Sometimes a quality stock, trading at lower volume levels could just mean that its either temporarily out of favor or undiscovered; not a poor stock or weak trend.
Obviously volume trends are important to the downside as well, but generally volume tends to be higher when stocks are dropping because of the effects of fear and panic. So you must account for this and realize that volume will almost ALWAYS be higher in a bear market compared to a bull market.
Volume isn't a cinch to read and big volume spikes with a huge move in a stock aren't necessarily good things either. Remember that a rising tide on an ocean beach doesn't just flood in, it is a series of ebbs and flows that gradually move the water up the beach.
Average daily volume on the nation's equities markets is down from 9.75 billion shares in 2009 to 6.45 billion shares in 2012. Markets were also in free-fall back in 2009, causing volume to surge.
Volume trends have also become a bit clouded with the introduction of HFT (High Frequency Trading), which is basically bogus volume that is occurring in large quantities between normal trades and prices.
According to Rosenblatt Securities, high-frequency trading accounted for 66% of equities trading in 2009, now that number is down to 50%. Program trading, which has been around a bit longer than HFT and accounts for roughly 30% of total NYSE volume, is also down substantially.
Program and HFT trading both are more prevalent and profitable in volatile markets, but drop off in low volatility environments like the one we are in currently. Between 2008-2011 the VIX averaged close to 26% and the S&P was moving over 10% per month on average!
Over the last year, the S&P's monthly volatility has been practically cut in half, with the S&P now moving at just 5.6% per month and the VIX at 11%.
But this is not necessarily a bad thing. Without the headlines, panic and stress, traders can take more time to think about their trades and be less reactive to the markets. Lower volatility in the markets usually means less trading by humans and less exploitation from computers.
It's not that investors have gone away; in fact, equity funds just recently saw the largest weekly inflows in history.
Look at how fund flows have been negative for 2011 and 2012, sure volume was a little higher...but is that the volume you want to see?
Volume doesn't have to be high to make money. In fact, trends can sustain without extreme volume and stable tends do best when volume is consistent. While volume does create stock prices, volatility is the genesis of higher volume.
From 2003-2007 the S&P 500 gained roughly 75% from low to high. In that time, volume in the SPY (Spiders S&P 500 ETF chart below) averaged a little over 900 million shares per month. Today, even with the decline in volume, the average is close to 3 Billion shares traded per month.
In my eyes, I don't see extremely low volume at all, just a return to normalcy from an unprecedented moment in history.
If markets could add 75% from their lows of 2002 on 1/3rd of the volume, why can't we add value now?
Options Volume on the Rise
As a professional options trader, I can honestly tell you that the option markets are where smart money goes to play. If a whale wants to make a trade (quietly and efficiently), he'll do so with a big option trade.
Roughly 4 billion equity options were traded in 2012, pepper in index options and futures and that number jumps to over 25 billion.
Even if we just look at the 4 billion equity options, thats the equivalent of 400 billion shares of stock (1 option generally controls 100 shares of stock) that are not being fully accounted for in volume tallies and are mostly in the bigger, more expensive names like Google, Apple, Priceline and the like.
Source : The Bloomberg Visual Guide to Options
What Does It All Mean?
The reality is that when you look at the long term trends, volume is actually on the rise. Sure volume has come in since the panic of 2009, but that was not a "normal" period to reference. Don't be misled by those who say that volume is low because all it takes is more buyers than sellers to make prices rise.
While volume anomolies should be noted and can be a sign of trouble, make sure you know exactly what is being measured. Big volume changes in a daily context can be used for strength and weakness in a short term trend, but don't get hung up on it.
The market's move higher tells me that there are more buyers than sellers, period. Even with the option markets and dark pools soaking up some of our volume, we are still trading 300% of the avearge volume between 2002 and 2007.
If anything, the technicals and fundamentals will guide us to the next level. For now, that level will most likely be higher after a short pause.
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Jared Levy is a Zacks Rank Senior Equity Strategist with a broad international following and deep expertise in technical trading. He provides private recommendations and commentary for the new Zacks TAZR Trader.