An analysis of NYSE trading volume provides one of the most intriguing big picture forecasts available to investors today. Trading volume, although not a short-term timing tool, acts like a lie detector.
Technical analysis 101 teaches us that higher prices on rising volume (often considered a break out) are bullish. Rising prices on falling volume or falling prices on higher volume, on the other hand, are bearish.
Low Volume But New Recovery Highs
Volume/price analysis is fractal and can be applied to all time frames. The break out above 1,389 for the S&P 500 Index (SPY) on August 3 happened on low volume. The rally from the June 4 low occurred on low volume and low and behold the rally from the October 2011 low has seen low volume.
Theoretically that’s all bearish, nevertheless the S&P 500 Index (SPY) just saw a 50-month price high as the Nasdaq carved out a 12-year high. Obviously, volume is not a short-term directional indicator.
Does that mean we should dismiss ominous volume patterns? I don’t think so and here’s why:
Stock Market X-ray
Volume, and volume sub studies such as the advance/decline ratio, reveal underlying tendencies that price simply doesn’t reflect. It’s almost like an X-ray for stocks and what this X-ray reveals is extremely interesting and concerning.
The chart below plots trading volume on the NYSE against the S&P 500 (since 2005). The daily gyrations of volume make it tough to discern a trend (the big spikes are usually triple witching days), but the red 50-day SMA shows a clear down trend in market participation.
Why Volume is Low
There are three reasons why trading volume is low:
1) Since the 2007 market top the value of the S&P, Dow Jones, Nasdaq-100, Russell 2000 and pretty much all other indexes has been cut in half, doubled and jumped around like a jittery cursor. Investors simply don’t want to put up with the market anymore. Who can blame them?
2) High-priced stocks like Google and Apple (GOOG and AAPL trade close to $700 a share) contribute to lower share volume. According to Tom McClellan, the median share price of all NYSE-listed and traded issues was $14.50 in 2009. Today it’s $23.50.
3) Summer trading is always slow.
Volume Pattern More Worrisome than Shrinking Volume
More worrisome than shrinking volume is the actual ebb and flow pattern of trading volume. Within the overall down trend in trading volume there are times when volume spikes quite dramatically. Those spikes reveal investors true feelings about stocks.
The chart below plots the S&P 500 against a 10-day SMA of trading volume. Most declines since the 2007 market top have been swift, so a 10-day SMA captures volume increases nicely.
The gray boxes highlight that selling activity increases whenever stocks decline. Numbers don’t lie, and volume is like a lie detector that reveals investors true intentions. On balance investors are more eager to sell into declines than buy into rallies.
What’s the big picture message of trading volume? Prices for the S&P 500, Dow Jones and almost all major market indexes are still below their 2007 high.
This means that the current rally is a counter trend rally, which is confirmed by rising volume when stocks drop and anemic volume when stocks rally.
Obviously, the market’s behavior has been distorted by the record influx of faux Fed money, but volume analysis strongly suggests that the rally from the March 2009 low will remain a counter trend rally. This rally may not be over yet, but it looks more terminal than many believe.