Do You Need Volume To Move Stocks Higher?

Many commentators have pointed out that the recent market action comes with volume consistently below its 50-day moving average. Standard wisdom says this is a period of distribution in the market and is therefore likely to lead to lower prices in the short term. This is shown in Figure 1.

FIGURE 1: Volume is shown in the lower part of this chart as red and green bars with the 50-day moving average shown as the line through that section.

We can also see from that chart that volume appears to move randomly while prices exhibit periods of trending behavior. Looking at the weekly chart in Figure 2, we see that volume appears to follow a well-defined three-month cycle. This chart uses the four-week rate of change in volume to identify significant increases and decreases in trading activity. The spikes occur every three months and are associated with the expiration of the contracts underlying the index in the futures and option markets.

FIGURE 2: Volume on the S&P 500 futures contracts shows clear spikes every three months.

Other technical tools may provide more useful insights. One of the first attempts to find quantitative meaning in the price/volume relationship is the development of the on-balance volume (OBV) indicator. Joseph Granville introduced OBV in his 1963 book, Granville's New Key To Stock Market Profits. The calculations are simple:

1. If the market closes higher than the previous day, the volume is added to the previous day's OBV.
2. On a down day, the volume is subtracted from the previous day's OBV.

A simple interpretation of OBV is to assume that it confirms price action if an increase or decrease in price is accompanied by increasing volume. Divergences occur when increasing or decreasing prices are seen with decreasing volume. Granville thought that this meant the price action was weak and more likely to reverse than continue in the direction of the trend. OBV is shown in Figure 3. Testing fails to confirm that this indicator adds value to the analysis of the trend.

FIGURE 3: On-balance volume adds little insight to the chart.

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MovingAvg (Volume * (Close - Close.1) / (True High - True Low), NumBars)

When backtesting with TVA, you do discover that meaningful and profitable information is contained in volume. On a daily time frame, a highly profitable system buys the market whenever the 10-day TVA is greater than its eight-day moving average. The test is designed only to capture the idea that increases in volume are bullish and therefore trades are closed one week later on a time stop. Using the Standard & Poor's 500 ETF (SPY), this strategy is profitable over daily and weekly time frames. Weekly trades are closed one month later.

The parameters used in the test were selected through optimization. While 10,000 tests were completed, parameter stability was found around these levels, which adds confidence to the analysis.

FIGURE 4: TVA offered a timely signal near the March bottom and is currently not bullish.

Testing indicates that the adage is right; markets do require volume to move higher. Unfortunately, more sophisticated analysis than relying on a moving average is required to determine whether volume is bullish. Investors should also be aware that a lack of volume, while not bullish, is not necessarily bearish.