In Wall Street circles, laments about limp stock-trading volumes are as common, and as banal, as complaints about the enervating summer heat. But the swelter of New York is about the same every year, and, as it turns out, trading volume isn’t particularly punk right now.
The relatively sluggish pace of share turnover that has accompanied the headline indexes’ steady march to record heights has been generally presented as a point of underlying weakness or market dysfunction. The Wall Street Journal headline “Dow Rockets. Volumes Plummet” was a blunt, flawed summation of this conversation, showing an apparently incongruous slump in shares traded as the market has soared.
Historically, a rally in a stock or an index has been viewed by technical analysts as being more valid, or “confirmed,” if it comes on heavy share volume — the equivalent of a high-turnout election delivering a strong mandate to the top vote-getter. Yet volume has been weaker on up days than down days for the entirety of this bull market, now older than five years, so it’s hard to place much weight on this old trading tenet.
The very fact that volume has tended to lag when stocks are rising has been offered as an indictment of the integrity of the uptrend itself, evidence somehow that equities are being manipulated higher during lulls in investors’ attention. There is a related concept tossed about that systematic trading algorithms falling somewhere under the heading of high frequency trading deter “real money” trading activity (thus reducing share volumes). Or, conversely, that the chilling effect of Michael Lewis’s recently published anti-HFT book “Flash Boys” has suppressed robot trading for now. Take your pick of one skeptical charge or the other, made by those who choose to look this gift bull in the mouth.
The reality, though, is that volume isn’t really falling. When measured in the only way that really makes sense – dollars – market activity has been holding firm at levels that comfortably exceed those of the prior bull market. Data furnished by Schaeffer’s Investment Research reveal the dollar value of stocks traded, shown here as a 21-day average of the 500 most active stocks, has been steady around $100 billion a day for the past few years.
For a quantitatively adept crowd, investment professionals are oddly uncritical in the way they go on tabulating trading activity the way it’s always been done – by number of shares traded. This is a relic of the inkwell-and-onion-paper days of a century ago. Trading was originally counted in shares because that’s how transactions were processed and paid for. In the era of fixed commissions, investors paid a set amount per 100 shares. While many trades are still priced per share, institutions often pay a percentage of value traded, and retail investors pay a set commission for any size order.
Dollar volume is a better gauge of how much stock is changing hands on a daily basis. This measure has held up better than share volume because the average price of a share across the entire market is at a record high today. Stock splits, once routine, have fallen from favor (the recent splits by Apple Inc. [AAPL] and Mastercard Inc. [MA] notwithstanding), which has lifted the nominal price of the typical stock.
Granted, that dollar-volume chart doesn’t present a picture of a particularly robust trading environment either. As the equity market has climbed in value, even steady dollar volumes mean a smaller share of overall stock-market capitalization is in motion on a given day.
There are a handful of plausible, largely innocuous explanations for this. Some of them are detailed in this Marketwatch slideshow, which nonetheless incorrectly characterizes volume as “crumbling.” The long-term surge in stock futures and options activity is the most persuasive concrete factor noted there. The rise of passive index-tracking exchange-traded funds as the preferred stock-ownership vehicle is also rightly fingered as a trend keeping volumes muted. Active fund managers have fewer dollars with which to swap in and out of favored names, and retail investors have not re-entered the stock-flipping game in large numbers.
One point not cited there: There are simply fewer stocks to be traded than there used to be. Companies themselves have been vacuuming up their own shares in recent years, purchasing more than $1 trillion worth over the past couple of years. The number of stocks on U.S. exchanges has dropped from a peak of more than 8,800 on major exchanges in the late 1990s to fewer than 5,000 today, thanks to smaller firms being taken private and regulatory deterrents to being a small-cap public company. The comprehensive Wilshire 5000 index – whose name dates from the 1970s and is based on an approximate tally for the investable stock universe – today contains just 3,688 stocks.
Finally, there is the likelihood that ever-higher volumes in the late 2000s were an aberration, the combination of electronic high-frequency trading strategies proliferating just as the financial crisis was driving an historic eruption of volatility and climactic liquidation of stocks.
Volume tends to follow share-price volatility – not the other way around – so the past couple of years’ muted market movements have restrained trading opportunities and turnover. So those vocally pining for higher share turnover will probably get it in the next correction – perhaps sooner and for a different reason than they were hoping.