Rises and Declines on High and Low Volume: Test Before You Invest

I've been hearing a number of commentators speculate on the validity of market rises and declines based upon the volume of shares being traded that day. So, for example, a rise on low volume is discounted and even looked upon bearishly, presumably because the higher prices are not attracting greater participation.

What gives me pause is that I never see any efforts to quantify such commonly-held wisdom. It's part of the technical analysis lore, but is it valid? Does volume on a rise or decline affect the market's subsequent behavior?

I went back to the start of 1999 (N = 2178 trading days) in the S&P 500 Index (SPY) and identified all instances in which the market either rose more than 1% in a day (N = 320) or declined more than 1% in a day (N = 340). I then calculated each day's trading volume as a proportion of the prior 200 days' volume and conducted a median split of the data.

That means that we're looking at strong and weak market days on high or low relative volume.

When SPY has been up more than 1% in a day (N = 320), the next day averages a rise of .02% (164 up, 156 down). When the rise is on relatively high volume (N = 160), the next day averages a flat performance (80 up, 80 down). When the rise is on relatively low volume (N = 160), the next day averages a gain of .04% (84 up, 76 down). Clearly, there's no general indication that a rise on high volume is any more bullish than one on low volume.

If we just look at those occasions in which SPY has been up more than 1% and volume has been twice (or more) the 200-day average (N = 37), the next day in SPY averages a gain of .06% (23 up, 14 down). This is a slight bullish edge in a limited set of circumstances.

If we limit our look to those occasions in which SPY has been up more than 1% and volume has been less than 80% of the 200-day average (N = 53), the next day in SPY has averaged a gain of .08% (29 up, 24 down). Low volume has not led to inferior next day returns for rising days.

Conversely, when SPY has been down more than 1% in a day (N = 340), the next day averages a rise of .15% (191 up, 149 down). When the drop in SPY is on relatively high volume (N = 170), the next day averages a gain of .16% (101 up, 69 down). When the drop in SPY is on relatively low volume (N = 170), the next day averages a gain of .14% (90 up, 80 down). Again, volume plays a very minor role in determining next day outcomes.

When we limit our look to those occasions in which SPY has been down more than 1% and volume has been twice (or more) the 200-day average (N = 57), the next day in SPY averages a gain of .37% (35 up, 22 down). That is a nice bullish edge, again in a limited set of circumstances.

Finally, if we examine occasions in which SPY has been down more than 1% and volume has been less than 80% of the 200-day average (N = 33), the next day in SPY has averaged a gain of .46% (19 up, 14 down). Interestingly, very low volume has been as bullish for declining days as very high volume.

The bottom line, it seems to me, is that greatly expanded volume on a rise or decline may be associated with better returns, but there is no evidence that low volume is followed by weaker daily returns. Indeed, when volume has been very low on rising and falling days, returns have tended, if anything, to be superior. Moderately elevated volume appears to have no significant impact on returns whatsoever.

Moreover, volume as a whole seems to play less of a role in next day returns than the simple fact of whether the prior day rose or fell by 1%. Returns were better following 1% declining days than 1% rising days regardless of market volume.

One has to wonder why traders would follow untested assumptions in putting their capital at risk. We're not talking rocket science here: my analysis required no programming and was conducted entirely in Excel in well under an hour. The moral of the story is to not accept market truisms on face value: Test before you invest.

RELEVANT POST:

Historical Patterns as a Heads Up in Trading
.