Low Volume: just ‘another broken indicator’ or something more?
Since the March 2009 low in the major stock indices, there has been waxing and waning interest in the reportedly low volume on up-moves. Is this just ‘another broken indicator’ or something more?
Firstly, lets review the evidence:
Taking a quick look at the S&P 500 and its volume over the past three years, it’s clear that volume has been low on up-moves and high on down-moves. Corroborating evidence is found in the PVO (at the bottom of the chart). The PVO is the ‘percentage volume oscillator’ that is like a MACD for volume. Looking at the chart above, it’s clear that volume has had positive momentum during price declines and negative momentum during price rises.
What is volume anyway?
Every time two people (or institutions) come together to swap money and shares, volume increases by the appropriate amount (e.g. Guy A swaps 1 stock A for $10 with Guy B => 1 share is added to ‘volume’).
The important point is that there have to be two entities with inverse preferences for a price to print and volume to be recorded. These two entities must have gone through a process of thinking (I use this term loosely!) to conclude precisely the opposite of one another. By and large, both entities think that their actions will result in gain. By the very nature of markets, this is impossible.
Ok, so what’s this low volume telling us?
The preferences of people and institutions are such that they can only swap relatively small amounts of cash and stocks with each other. In other words, the level of ‘deal finding’ is low among market participants; people do not have sufficiently polarized opinions to produce ‘high volume’.
What does this mean for the contrarian investor?
In the realm of financial speculation, the two people who execute against one other both think they can profit. So this low volume is saying that most of the people who were going to execute have already executed. Now, they have to ‘wait and see’ if they’ll profit. So – as a contrarian – I ask: Who’s going to give up first? Those who are long? Or those who are short? Will such ‘giving up’ be muted or explosive? Is there potential for cascading trades?
In short; who is the loser? Or put more gently, who has the weaker hand? Who’s consensual in their (supposed) thinking?
The ‘right’ answers for these questions will be different for everyone. It depends on your timeframe, lifestyle, capacity to stand drawdowns etc. (For example, consider the fact that when you execute a successful trade, there are different people making (and losing) money by being long (if you’re short) or short (if you’re long) at smaller and larger timeframes. This doesn’t take away from your success; you were right against the person who executed against you on the same timeframe.)
What’s my opinion (in the context of my own circumstances)?
As I explained here – in my timeframe - I think some people who are long have acted on false premises, and so I want to be short (and/or out). However, I am (perhaps dangerously) attempting to ‘time’ the markets in a way. If I had a longer-term outlook and a higher capacity for drawdowns, I might easily conclude that I’d have to be long. For in this case I would regard the ‘weak hand’ as anyone owning fiat currencies, IOUS on fiat currencies (e.g. demand deposits) and government IOUs. Furthermore, this incessant low volume is telling me that the stock-market rise has been a story of bear capitulations. For me, it’s saying: ‘we’re coming close to the end of the conversion process; whoever was going to convert has converted.’
[A note on market philosophy:
In case some of the above concepts seem unfamiliar, let me elaborate. When a shoemaker sells shoes to shoe-buyers, the terms of trade are clear: the shoemaker wants money and the shoe-buyer wants shoes. However, in the business of financial speculation, both sides want the same thing (profits), but both can't get it (one pays the other). We cannot say in a coherent sense that the 'money makers' are buyers of the stock market, can we? Things change, and the 'money makers' perpetually switch from one side to the other; often in a foxing and paradoxical fashion. So as financial speculators, we're in the business of attempting to be on the right side of this equation (and we're subject to the sway of being on the wrong side).
For a nice and simple explanation about supply and demand in financial speculation, see Robert Prechter's video here.]