Some investors are becoming concerned about the fact that while major stock market indices are nearing all-time records, the volume of shares traded is going down.
The significance of trading volume is one that a lot of technical analysts struggle to really understand, or at least gain a reasonable understanding of them. There are some pretty famous ones that have designed indicators that use volume as a major input, even though it doesn’t really make sense to use volume this way, but this is by no means a simple matter.
It’s not that we can’t use volume to gain some insight at times, but it is only meaningful when we put it together with whatever is going on with price. It is only when both volume is higher and price movements are more significant that volume really contributes anything meaningful to the story, and even then, we need to be careful not to assign more weight to it than it merits.
If professional technical analysts struggle with this and so often assign more importance to volume than it makes sense to, non-technical analysts, and especially lay people, will really be out of their element with it. When we see concerns expressed in the media about the low volume we’re seeing lately, we really need to take a step back and think about this a bit before we come to any conclusions here, even one that has this a mild concern.
Buying and selling ever occur in isolation. If we see the market go up in price, this does not mean that there is more buying, or more selling when the price goes down. Every trade involves buying and selling and with a certain volume, a certain number of shares have been at an uptick or a downtick but the number of shares bought and sold is always identical.
Price Trends Themselves Define Price Trends
The distinguishing feature of up or down markets isn’t the volume, it is the price movement, because this is how we measure things, and is actually driven by sentiment and not volume. The price is the amount that people are willing to pay, and movements in these amounts over time define our trends. The price of shares do not even require a single trade to move price, as this can happen just from changes in the price that people are bidding for them and asking for them.
Price does normally move with trades, but it is not so much that the trades moves prices, and the prices move first generally. For example, if a piece of news hits the market, the asking price raises up and then people start lining up to pay these prices, but someone is selling to them at these higher prices, therefore both sides have been affected by the changing sentiment.
Whatever price stocks trade at therefore involves an agreement between the buyers and the sellers, and when they agree on a price, a trade is made. Even in a crash, the buyers line up alongside the sellers, and it’s the price expectations of both parties that are lessened. They tend to lessen by way of a series of trades, which we call momentum, and momentum really exists independent of volume.
Looking at price always tells us what is going on with price, and if a market has moved up 10% for instance, it’s because the assets used to trade 10% lower and we’ve moved up that far. This can happen in both a thin and heavily traded market, and we can also have either when the price doesn’t move much at all.
How much participation there is in a trend is another story though and this can sometimes speak to the potential out there. Volume is only meaningful relative to a volume from another time period, and we can see that volumes have been declining in 2019 after a more heavily traded fourth quarter of 2018, when we saw a big move to the downside.
The heavier volume during that quarter didn’t cause the drop, but it did indicate that the level of participation was higher than the level we’ve seen with the rebound this year. If you are a bull, it’s actually better to have price move with less participation, as higher volumes generally mean that the forces causing the move may be peaking. Lower volume trends therefore tend to be more sustained, which includes sideways markets.
Volume Can Tell Us A Little, At Certain Times
As we’ve deepened our understanding of technical analysis over the years, we’ve moved away from paying as much attention to volume as we used to, generally speaking anyway. Volume does oscillate quite a bit and in ways that aren’t really meaningful at all, as a result of factors other than price in other words, but sometimes price does drive volume, with the bigger up or down moves that attract more participation.
During our 2019 rally, there has been less participation, less shares being traded overall, but we’ve still seen a big gain. Volumes have been dropping even lower over the last 6 weeks, and are now at their lowest levels since September. Volume did pick up over the next 3 months in September, but prices also went down a lot too, and these variables are really quite independent.
If we are hoping that a move in one direction or another will be more sustained, it’s actually preferable that volumes be on the lower side. This current situation represents a clear example of this, where it’s thought that a lot of the money that exited stock markets during late 2018 have still not rejoined, and they at least could.
Conversely, when we moved from the more bullish time in September to Q4’s big loss, changing sentiment caused a lot of investors to close their positions, but this was done on a scale that ended up not being sustained. It wasn’t the volume that did us in here, but more people running scared made it easier to reverse this when the time was right and the mood changed.
Volume analysis is therefore not something we can apply generally, it is much more situational than this, but in our current situation, slow and steady is exactly what we should want. As long as prices are moving up, we’re still in good shape, and if lower volumes still move the market along nicely, that’s even better.
If we see both price and volume moving together a lot, that’s what we want to be wary of, although price moving this way is enough reason to be wary. Volume in this case can be seen as additional information though, negative information in this case, where low volumes right now can be seen as mildly positive.
Slower and steadier also tends to limit profit taking, where sharp moves at higher volumes may influence people to take their profits quicker, and there is a lot of money in the market that is quite prone to this after a spike.
Some may claim that volume continuing to drop may indicate a reversal coming, but this really only happens if the mood of the market changes. We might think that this less participation makes it easier for the other side to take over, but this really depends on shifting sentiments where historic volume becomes just old news.
Less people felt the need to trade over these last few weeks, but that’s about it. If people get scared and more feel the need to sell, this can move the price in some cases, but this depends on the willingness of those who will be selling their shares to them. When both sides agree, this is when we see the real moves.
Stock markets are very dynamic and while we can learn a little looking at recent volume, this all changes daily, and we are really limited to the amount of potential that one side may have, with the bulls perhaps having more potential right now based upon this. This is not something to be afraid of really. If the monsters do come, we won’t have to look anywhere this hard to see them.