Where’s the volume?

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By Chris Becker

Following on yesterday’s post about the complacency around volatility, as measured by the CBOE Volatility Index or VIX, and further questions around the blogosphere on who’s buying this rally, the next question to ask in this rally is where’s the volume?

Normally, I don’t use volume as a technical indicator, but like margin lending aggregates, futures positions, cumulative fund flows, bull/bear sentiment indicators and the like it does have relevance in framing the bigger picture.

And that picture is looking further muddled – here’s the All Ordinaries (XAO) using a monthly price and volume back to 2000:

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As expected in a secular bull market, and in particular the bubble in Australian stocks between 2003 and 2007, volumes increased year on year (note the 12 month moving average of volume). However, this trend has reversed in the secular bear market we are currently in as prices slowly melt, volume steps away.

To clarify a myth, this does not mean there are less buyers and more sellers, it means there are less transactions. This is an important point to make – prices cycle up due to more participation, i.e more transactions. This happens in every asset market – note the melt in property prices, due to a lack of selling. If assets don’t sell, they don’t move.

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But the picture gets interesting when you use the same chart and timeframe over the US S&P500 Index:

Volume has structurally declined since the March 2009 bottom, yet prices have risen through various cycles of monetary and fiscal stimulus. Recent volume has been extremely low, as pointed at by Bill Hardison at dshort.com with this chart of the 5-day moving average of volume for the Exchange Traded Fund for the S&P 500:

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As he explains (with emphasis added):

The green arrows mark the volume around the Christmas holidays each year, which is almost always a time of light trading. Of the 5 past holiday periods, the moving average of volume went below 100 million shares per day 3 times. The red arrows mark the only other times during the past 5 years that volume dropped below 100 million: the market peak of 2007, and now. Unusually light volume showed the reluctance to buy at the peak in 2007 — and appears to be showing that same reticence now.

Bill then goes on to argue that this similarity to the “reluctance to commit funds at the peak in 2007” suggests the market is near a top. I’ve contended for awhile through my own studies, although I thought it would require QE3 to do so, that the S&P500 would get to 1500 or even 1550 before a meaningful correction.

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Considering that the ASX200 follows the S&P500 in lockstep, this volume study is something worth considering when managing risk in your portfolio.

Chris Becker is an investment strategist at Macro Investor, Australia’s leading independent investment newsletter covering stocks, trades, property and fixed interest. A free 21-day trial is available at the site.

You can follow Chris on Twitter.

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