Don't use volume for trading


Many short term traders like to use the market’s volume as an indicator for trading. I don’t. We did extensive studies on volume and always came to the same conclusion:

Rising/falling volume isn’t a bullish sign or a bearish sign. It just is. Volume is mostly irrelevant. It doesn’t give you much of an edge in the markets.

Conventional trading “wisdom” for volume indicators

Volume measures how many shares were traded in a specified period of time (e.g. 1 day, 1 hour, 30 minutes). It is frequently used as a confirmation indicator in conjunction with other technical indicators.
Conventional trading wisdom states that volume is used to “confirm” trends.

  1. A trend that’s confirmed by “rising volume” is a real trend that will continue.
  2. A trend that’s NOT confirmed by “rising volume” (i.e. volume is flat or falling) is a fake trend that will end soon.

The “logic” behind this is simple.

  1. More and more traders/investors should jump on the bandwagon if a trend is real and will continue.
  2. Conversely, fewer and fewer traders will trade on the side of the current trend if they think that the trend will end. A trend + falling volume means that traders are expecting a trend reversal.

For example:

  1. A market that rises on rising volume = bullish.
  2. A market that rises on falling volume = bearish.
  3. A market that falls on rising volume = bearish.
  4. A market that falls on falling volume = bullish.

Our backtests have demonstrated that the above assumptions are not true. Volume cannot be used to consistently and accurately confirm or disprove trends.

Do not use volume for trading

Volume – regardless of whether it’s rising or falling – is neither bullish nor bearish for the market. It’s just a fact, like stating “the market went up/down today”. It has no predictive value.
Volume ALWAYS rises when the market crashes. Volume ALWAYS falls when the market rallies from the bottom.

  1. Conventional wisdom states that rising volume is a bearish sign when the market is crashing: the market will fall even more.
  2. Conventional wisdom states that falling volume on a post-correction rally is bearish.

This simply isn’t true.

  1. Volume ALWAYS rises when the market crashes. This is part of the definition of a “crash”. Traders and investors panic sell, so volume naturally spikes.
  2. Volume ALWAYS falls after the correction bottoms because volume was abnormally high during the correction. Rallies occur when traders and investors are more calm. There is no panic selling, so volume naturally subsides.

Here’s a simple example with $SPY in February 2018 (S&P 500 ETF).

Here are a few more examples with $SPY in 2016. Falling volume was never a bearish sign for the stock market.

Here’s another example from 2014.

Notice how volume is not a leading indicator. It is a coincident indicator that has almost no predictive value.
Some of the strongest rallies occur on low volume
Low volume rallies are not bearish. There has to be buyers AND sellers for “volume” to exist. A rally that’s accompanied by low volume means:

  1. There are more buyers than sellers – that’s why the price is going up.
  2. There are few sellers – that’s why volume is so low.

Some of the strongest rallies in history occurred on low volume. The market grinded higher incessantly over months. Anyone who turned bearish because “volume is low” would have been dead wrong.
Here’s an example. Notice how $SPY volume was low from 2013 to the first half of 2014, but the stock market still soared.

Here’s another example. Notice how $SPY soared from mid-2016 to 2017 “despite” low volume. Volume was substantially lower than it was from 2015 to mid-2016.

Think about the inverse logic. Soaring volume on a market crash isn’t “bearish”. A crash that’s accompanied by surging volume means:

  1. There are more sellers than buyers – that’s why the price is going down.
  2. There are still a lot of buyers – that’s why volume is so high. You cannot have “volume” if there are no buyers.

Sometimes volume soars because the market’s nominal price is lower.
This is common among leveraged ETF’s that lose value to erosion over long periods of time.
Volume is supposed to represent “interest” in a market. A better measure of “interest” is volume*price. Sometimes volume will soar just because the market’s price is a lot lower.
If the market’s price falls by 90%, traders will need to trade 10x the number of shares in order to have the same position sizes. Volume will naturally spike.
Here’s an example with $NUGT, the 3x leveraged ETF for gold miners. Notice how volume surged from 2013-present. That isn’t a bullish sign. It’s merely because NUGT crashed. Traders need to trade a lot more shares in order to have the same position sizes.

4 comments add yours

  1. ‘Think about the inverse logic. Soaring volume on a market crash isn’t “bearish”. A crash that’s accompanied by surging volume means:
    1. There are more buyers than sellers – that’s why the price is going down.’
    Typo? Shouldn’t it instead be: “There are more *sellers than buyers*…”?

  2. Finally someone came out and said what I have thought for years. Been looking at volume and price for a quarter century now and darned if I could ever make any consistently valid correlations between volume and price in ANY market phase! AND that includes comparing volume by price plotted on the Y axis as well as volume on the vertical scale plotted along the X axis, at the same time. I thought I must be kinda dense as I just wasn’t seeing what the “gurus” were seeing.

    • Volume can be used to “predict”, but it has waaay too many false signals. In other words not consistently accurate.

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