Why has my volume gone so low?
A stock’s trading volume is a key indicator of investor interest and activity. It reveals how many shares are exchanging hands over a given period. Imagine noticing that ABC stock, which normally trades 2 million shares daily, suddenly dropped to just 300,000 shares today. This significant decline in volume could signal waning enthusiasm and participation in the stock. Low trading volume can have important implications for a stock’s price action and volatility, yet the underlying causes are often unclear.
Define Trading Volume
Trading volume refers to the total number of shares or contracts of a security that are traded during a given period of time. It is a measurement of how much of a stock, ETF, or other financial instrument is being bought and sold in the markets on any given day, week, or month (1).
For stocks, trading volume represents the number of shares that change hands between buyers and sellers during a trading session. For ETFs and mutual funds, it represents the number of shares traded for a particular fund or the total value of shares traded (2).
Volume provides an indication of the liquidity and interest in a particular security. High volume suggests high liquidity – that the stock or fund can be bought and sold easily. It also indicates trader interest or unusually high or low volatility. Low trading volume conversely suggests low liquidity and low investor interest (3).
Understanding trading volume and monitoring any significant changes can provide helpful context for interpreting price movements and assessing the overall health of a particular security.
Sources:
(1) https://www.etf.com/etf-education-center/etf-glossary/trading-volume
(2) https://fastercapital.com/topics/the-definition-of-trading-volume-and-why-it-matters.html
(3) https://medium.com/@axehedge/a-to-z-of-stock-trading-volume-65398fbbfe6a
Why Volume Matters
Trading volume, which refers to the number of shares traded in a security over a specific time period, is an important indicator for both traders and investors (Lo & Wang, 2009). High trading volume generally signals interest in a stock, which can drive up the share price. Stocks with low volume may be difficult to buy or sell when you want to trade.
High volume indicates significant interest and liquidity in a stock. More buyers and sellers increases the chances of executed trades. High volume also reflects greater participation and confirms trends. Meanwhile, low volume signifies limited interest, lack of participation, and potential illiquidity. Low volume makes it more difficult to buy or sell shares when you want to trade.
Overall, volume provides valuable insights into market activity and confirms price trends. Understanding volume is critical for effective trading and investing.
Reasons for Low Volume
There are several factors that can contribute to low trading volume in nonissuer transactions (https://fastercapital.com/keyword/low-trading-volume.html). One common reason is lower participation in the market. When fewer traders and investors are actively trading a stock, volume will naturally decrease. Lack of volatility or significant price movement can also lead to decreased volume, as traders await opportunities and may stay on the sidelines (https://www.quora.com/What-does-low-trading-volume-indicate). In addition, seasonal slowdowns around summer months or holidays may temporarily suppress volume as people are away from the markets.
Another major reason is illiquidity in the stock. When the bid-ask spread is very wide, and there are few market makers, volume will be lower due to decreased activity. Thinly traded penny stocks and microcap companies often suffer from heavy illiquidity. Overall, understanding the underlying reasons for shrinking volume can help traders adjust their strategies accordingly.
Lower Participation
One reason for lower trading volume is a drop in participation from active traders and investors. When fewer market participants are trading a stock, less volume is generated. This is often seen as a reflection of waning interest in the stock.
Lower participation tends to occur when traders believe a stock or the overall market lacks a clear direction. With uncertainty about which way prices will move, some traders sit on the sidelines until a trend emerges. This thinner participation leads to lighter trading volume.
According to a study by BestEx Research, lower participation rates are correlated with lower trading volumes as a percentage of total volume (Rethinking Participation Rates and RATS). When fewer traders are active in a stock, the number of shares changing hands drops.
In addition to signaling a lack of conviction in a stock’s direction, low participation can also reflect disinterest, reduced attention, or limited capital among potential traders. With fewer buyers and sellers trading, volume dries up.
Lack of Volatility
There is often a direct relationship between a stock’s volatility and its trading volume. When a stock experiences high volatility with large price swings, it tends to attract greater trading volume as more traders look to capitalize on the price fluctuations. However, during periods of low volatility when a stock’s price remains relatively steady, trading volume can dry up as there are fewer profitable trading opportunities.
According to research, stocks with high daily trading volume tend to be less volatile in general (https://www.investopedia.com/ask/answers/09/daily-volume-volatility.asp). The reason is that stocks with greater liquidity and trading activity tend to have more market participants. This makes the stock price more stable and less prone to dramatic swings. With more traders available on both the buy and sell side, shocks to the stock price are better absorbed.
During periods of low volatility, there are smaller price fluctuations which offer fewer short-term trading opportunities. Traders may move to more volatile stocks or asset classes, further reducing volume. This creates a feedback loop where low volatility leads to low volume and vice versa. Understanding this relationship can help traders identify when market conditions are changing.
Seasonal Slowdowns
Trading volume often experiences predictable dips during certain times of the day or year. According to a study published in the journal Business Perspectives, seasonality in trading volume of stocks is observed at different intervals throughout the day and year. The most significant seasonal slowdowns occur at the beginning and end of the trading day, with volume lowest at market open and close (Source).
Additionally, trading activity tends to decline around major holidays and summer months. For example, volume is typically lower around Christmas, New Year’s, and Independence Day in the U.S. Volume also dips in August when many traders take summer vacations (Source). Being aware of these seasonal volume patterns can help traders plan trading activities and set expectations.
Illiquidity
Illiquidity refers to a lack of trading activity or buying and selling interest in a particular security or market. When a stock is considered illiquid, it means there is a low volume of shares trading hands every day. This lack of liquidity makes it more difficult for investors to buy or sell the stock without causing large price swings. There are a few reasons why illiquidity can reduce trading volume:
First, when a stock is illiquid, there may not be enough buyers and sellers interested in trading that stock to facilitate regular transactions. High levels of illiquidity mean trades cannot be executed easily. With fewer market participants willing to buy or sell, overall volume decreases. According to a 2018 journal article, the correlation between illiquidity and trading volume is significantly negative (Source).
Second, illiquid stocks tend to have much wider bid-ask spreads. This refers to the difference between the highest price a buyer is willing to pay (bid) and the lowest price a seller is willing to accept (ask). Wider spreads make trading more expensive, which disincentivizes investors and results in lower volume. A 2011 study in an academic journal found evidence that wider spreads significantly reduce volume (Source).
Finally, when transaction costs are high due to illiquidity, big trades can cause large price movements in the stock. This increases volatility risk, making investors more hesitant to trade. Lower participation leads to declining volume. Overall, multiple factors related to illiquidity reduce the ease, incentives, and willingness to trade, which directly lowers volume.
Strategies to Overcome
There are a few strategies traders can employ when dealing with periods of low trading volume:
Wait it out: Sometimes low volume periods are temporary, caused by seasonal slowdowns or lack of volatility. Traders may opt to reduce position size and wait for volume to pick back up.
Shift strategies: Low volume conditions favor certain strategies like range trading or short-term scalping over trend trading. Traders can shift to strategies suited for low volume environments.
Find a new trading vehicle: If low volume persists in a particular asset, traders may switch to securities with higher volume and liquidity.
Go where the action is: Certain sectors or asset classes may have higher volume than others during slow markets. Traders can shift their focus accordingly.
As an example, cryptocurrency traders dealt with low volume during the 2018 bear market by shifting strategies or trading different cryptos than Bitcoin which had relatively low liquidity (source).
Conclusion
In summary, low trading volume can be caused by several factors. Lower participation from investors can reduce volume as fewer traders are active in the market. A lack of volatility and direction leads to less trading, while seasonal slowdowns like summer also see decreased activity. Finally, illiquid stocks with a small float will naturally have lower volume.
While low volume can seem concerning, it’s not necessarily a negative if there are understandable reasons behind it. Investors can employ strategies like widening their trading universe, focusing on relative volume, or seeking leading indicators. Overall, volume provides helpful additional context around price action. Understanding the reasons behind volume trends leads to better informed trading decisions.
The key takeaways are that volume has important implications for technical analysis and market movements. Evaluating volume requires looking at historical averages, peer group comparisons, and the market environment. There are identifiable reasons volume may decline, and traders can adjust using proven tactics. With the right insights and strategies, low trading volume does not have to be an obstacle.