Why The 'Low Volume Is Bearish' Crowd Is Totally Wrong

Ryan Detrick is the Senior Technical Strategist at Schaeffer's Investment Research. He has the uncanny ability to connect the dots in a market that seldom makes sense.

I’m starting to hear how volume is ‘light’ and this is somehow bearish for stocks again.  My big issue with this statement is I started hearing it back in mid-2009 and have been hearing it a few times a year since even as we continue to make new highs.

Recently, I put a stake through the heart of the ridiculous ‘we’ll crash now because things look a lot like 1929’ argument.  Now I’ll tackle the ‘low volume is bearish’ argument and show it simply isn’t true.

First things first, NYSE volume has been dropping - that is a fact.  Of course, it has been dropping for years while the bull market continues to thrive.  Here’s a 100-day moving average of NYSE volume and the S&P 500 (SPX).

Let’s think logically here.  After the recent crash we lost a generation of investors.  That right there means volume could be lower.  How many times has the average investor said the whole thing is a house of cards, only propped up by Bernanke?

But it doesn’t end there.  Of course we’ll have less volume now, stocks cost more.  You will see a lot more volume when Bank of America (BAC) is trading around a buck, than when today’s big names like Chipotle Mexican Grill (CMG) is at $500 or Priceline.com (PCLN) and Google (GOOG) are up over a $1000.

Sure, trading volume is lower but what about the total dollar value of that volume?  Let’s do something that includes the price of stocks, not just the volume. 

Let's look at all the stocks in the SPX to find their daily average dollar volume (stock price times stock volume). Then, to smooth things out, we'll make a 21-day moving average of the results.

Below is a chart of what was found. First things first, total-dollar volume is indeed less than during the peak of the financial crisis. However, it’s also still well above the bull market from 2003 to early 2007. So again, a very simple question comes to mind: If total-dollar volume is higher now than the last bull market, how in the world can bears say lower volume is bearish?  Not to mention that spikes in volume tend to occur during pullbacks!  So volume is higher now than the last bull market and higher volume is actually bearish, not the other way around like so many claim.

Punching some holes in the whole thesis of ‘low volume is bearish’, now let’s dig in even more for the technical knock out.

My theory has long been that the only investors left are more sophisticated, so they don’t trade stocks as much Check out what is happening in the VIX options.  In order to hedge, VIX calls have seen explosive growth.  Someone is putting money to work here and they aren’t just buying stocks.

Lastly, option volume has been climbing steadily for years.  Again, one look at the chart below and it is very clear that instead of trading stocks, trading options has become much more popular.  To put it bluntly, stocks are no longer the only game in town anymore.

There you go.  Stock volume might be low, but that isn’t bearish and volume in options could very well be where many investors have moved over the years.

So the next time you hear a talking head try to warn you that we need volume to ‘confirm’ this bull move, just remember we’ve heard that before and it simply isn’t true.