Traders and technical analysts typically pay close attention to volume statistics. In and of itself, volume does not offer much insight into a trading or investment decision. Volume is best viewed on a relative basis. If I tell you that a stock traded 10 million shares yesterday, that number on its own is essentially meaningless. It completely lacks context. If I tell you that the average daily volume in that stock is 2 million shares, it would be normal for you to wonder why yesterday’s volume was 5X normal. If it normally trades 10 million shares a day, you would probably be unimpressed. Traders typically look to see whether a large move in a stock is accompanied by heavy or light volume, “heavy” and “light” can only be judged in comparison to the stock’s prior volume history. 

A classic investment truism is the larger the volume, the more meaningful the price movement. Higher volume reflects higher conviction by the buyers or sellers who are driving the price action, while moves on lighter volume tend to be perceived as more likely to be transitory. One of the hallmarks of the stock market’s rise off its pandemic lows was a spectacular increase in volume. Investors of all types were participating in the advance, and much was written in the media about the new wave of individual investors who began participating in investment markets. The consensus view, which I share, was that the rise that we saw during the past 12 months was largely a high conviction move, as evidenced by stellar volume statistics.

With that in mind, consider the following chart:

S&P 500 Index (SPX, blue) vs 20 Day Moving Average of Total US Share Volume (magenta), 5 years

Source: Bloomberg

In the chart above, I chose to use the 20-day moving average of US share volume to smooth out the noise in the daily statistics. (There are about 20 trading days in a calendar month)We see that there were volume spikes around the various declines in SPX, but that the pandemic drop in early 2020 resulted in volumes that were more than double the norms of the prior four years. Even as the volume spike passed, volume levels never fully reverted to those historic norms. We have become quite used to higher trading volumes. Interestingly, the volume spiked earlier this year on a rally though. The following chart shows this in more detail:

S&P 500 Index (SPX, blue) vs 20 Day Moving Average of Total US Share Volume (magenta), 6 months

It turns out that the highs in volume roughly coincided with the height of the craze that surrounded GameStop (GME) and other “meme stocks”.In hindsight, the volume wave was not surprising, though it was somewhat unusual to see a volume pop in a generally rising market.

What then are we to make of the fact that the latest leg up in SPX is being done on decreasing volume? If technicians want to see market moves confirmed by higher volume, meaning higher conviction by buyers, then there is some risk to seeing an upward move on lighter volume. This would not be considered a red flag to most analysts, but it is not a positive sign either.

We see a similar pattern in options markets, as evidenced by the following graph:

Total US Call Options Volume (green), Put Volume (white), and Put/Call Ratio (red), 2 years

(Click on image to enlarge)

As we saw with stocks, options volumes rose throughout most of 2020, peaking in late January of this year. Much of the rise was seen in short-dated, out-of-the-money call options that are purchased primarily by speculators. In contrast, we see that put options volumes have stayed largely in the range that we saw throughout the 2 year period. As call volumes fell in the past 2 months, we saw a brief spike in the put/call ratio, but that index has reverted to the low levels that have characterized the past 6 months. Again, we need to consider the ramifications of the decline in call options volume for the recent rally. It is not necessarily a negative if speculative fever is diminishing, but we need to consider whether those speculators are required for the current advance to continue.

 If the current volume trends continue, we will need to address the question about the sustainability of the rally and the conviction of the investors who are driving prices higher. Volume trends are rarely a pure signal, but they can provide important confirmation to the moves in a given stock or index and can offer a clue about whether those moves are sustainable. Stay tuned.

Chart Sources: Bloomberg