What On Earth Has Happened To The Volume?

Volume is the lifeblood of active traders. It’s the ocean in which market transactions are completed easily, quickly and without slippage. Sufficient volume provides traders the ability to move quickly in and out of securities without delay. Volatility and volume generally move in the same direction, with higher volumes usually combining with higher volatility and vice versa. Unfortunately, traders are currently facing a low-volatility, low-volume stock trading environment.

Volume has been plummeting for the last three years. Things are worse now than they were even after the great crash of 1987 and the dot-com bust of 2000. What’s happening to the volume and how can active traders find profits in the current low-volume, low-volatility market?

A decline in retail stock investing is one reason volume is dropping. Retail investors directly or indirectly own about 50% of all stocks. The first decade of the new millennium was the S&P 500’s worst calendar decade of all time, with a 10% loss. This downtrend frightened large numbers of retail investors away from the stock market, and they reallocated their investable funds to so-called safe haven assets such as government bonds, precious metals and the U.S. dollar.

Pension plans, which hold about 20% of all U.S. stocks, have also become gun-shy when it comes to equities. These retirement plans need to make a return and have reallocated funds outside the equity market in pursuit of more reliable yields.

It’s a Catch-22; weak performance results in players slashing their exposure to the stock market, which begets low volume, creating a difficult trading environment that drives even the hardiest of traders away in search of returns.

On the bright side, exchange-traded funds have not suffered nearly as badly as stocks in the volume category. In fact, ETF volume has remained flat over the last decade, with approximately 1.5 billion shares traded daily. Interestingly, the SPDR S&P 500, which reflects the broad market, actually increased in volume in 2011. The volume of American Depository Receipts, designed to allow U.S. investors to trade foreign stocks on U.S. exchanges, has also increased.

In addition, the stock market has rocketed higher by 100% (as measured by the S&P 500 index) since 2009. These facts are what keep stock traders plying their trade despite the difficult environment they currently face.

Given the present low-volume, low-volatility environment, what’s a time-proven tactic traders can use to create profits? One traditional and highly effective method of dealing with a combination of low volume and low volatility is the common covered call strategy, where the trader sells one call option contract per 100 shares of a stock. The goal is for the low volatility to continue, allowing the call contract to expire worthless, thus creating income for the trader despite the underlying stock not moving much. There are obvious risks involved, such as limiting returns if the stock goes up, but this tactic remains a powerful tool in the professional trader’s toolbox.

Will the volume situation improve? Will the strong stock market performance of the first quarter of 2012 attract more and larger players to the game? It’s likely that the recent robust performance will increase investors’ confidence in the market, but when that will translate into a volume upswing is anyone’s guess.

Lime Brokerage LLC is not affiliated with these service providers. Data, information, and material (“content”) is provided for informational and educational purposes only. This content neither is, nor should be construed as an offer, solicitation, or recommendation to buy or sell any securities. Any investment decisions made by the user through the use of such content is solely based on the users independent analysis taking into consideration your financial circumstances, investment objectives, and risk tolerance. Lime Brokerage LLC does not endorse, offer or recommend any of the services provided by any of the above service providers and any service used to execute any trading strategies are solely based on the independent analysis of the user.

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