'Dull' Stock Market Just Waiting To Catch You Off Guard

Should one avoid stocks when trading volume declines? This question is particularly relevant as we enter the summer months, which traditionally experience a decrease in trading volume. According to some technical analysts who argue that price follows volume, it implies that the U.S. stock market is likely to trend downwards until the end of August.

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However, it would be unwise to rely on this assumption. Upon careful analysis, there is no statistically significant relationship between the stock market's performance and its overall trading volume. Even if the stock market were to decline during the summer, attributing it solely to low trading volume would be misguided.

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To provide a clearer perspective, let's examine the chart below, which illustrates the average trading volume of each month relative to its trailing 12-month moving average. This metric is crucial given the significant expansion of trading volume over the past five decades. Notably, there is a distinct decline in volume over the six-month period starting from March, with August's average volume being 15% lower than that of March.

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Further evidence that disproves a straightforward relationship between trading volume and returns is observed in September's performance. Despite being the weakest month historically, its average trading volume is comparable to or even higher than five other months.

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Statistical analysis confirms these observations, as there is no statistically significant correlation between trading volume across all months and the stock market's subsequent performance over one, three, six, and twelve months. These correlations were assessed using the widely accepted 95% confidence level utilized by statisticians to determine the genuineness of patterns.

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A common counterargument I have encountered when presenting similar findings in the past is that it is not the higher trading volume alone that indicates bullishness, but rather the combination of increased volume and rising prices.

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However, this argument does not hold merit either. To address this, I categorized all months over the past fifty years into two groups: the first group consisted of months with above-average S&P 500 trading volume and a rising stock market, while the second group included months with above-average volume and a declining market. The summarized results, presented in the table below, indicate that none of the differences observed are statistically significant.

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In conclusion, this case aligns with the wisdom prevalent on Wall Street. As the old saying goes, it is unwise to short a market that lacks volatility.

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