Tuesday, August 26, 2014

Why Quiet Markets Can Be Hazardous to Your Wealth

If you click on the above chart, you'll see the rolling 50-day average of volume in SPY and the rolling 50-day average of daily trading range in SPY.  What is clear is that:  a) volume is closely correlated with index movement (the daily correlation over this period is .84); and b) volume and volatility have been crushed in the past several years.

The excellent Quantifiable Edges site points out that, since 2012, low volume on market strength has not been bearish.  Traders looking for volume confirmation of market strength have missed an important dynamic of this bull market.

Eldad Nahmany points out a very interesting study in which subjects found that having nothing to do was an aversive state--so aversive that they preferred painful activity to no activity.  The implications for trading in quiet environments are significant:  With little movement to stocks, traders needing movement might gravitate toward bad trades over no trades.  Such overtrading may not simply be a matter of poor discipline or lack of trading plans.  Rather, it would be the result of a failure to tolerate inactivity. 

As I've pointed out in other contexts, we are never alone and we are never without activity.  There are simply times when what we have is our own company and the activity of our own thoughts.  How well we tolerate our own company may be an important--and poorly appreciated--predictor of trading success...especially in quiet markets.

Further Reading:  Are We Headed for a Stock Market Crash?