Higher Stock Prices on Declining Volume, a Major Red Flag?

Stock Market Pit 1

The February rally has brought stocks back up near their all time highs.

The rise to new all time highs followed by a few percent pullback (6% in the market’s latest case) has been the market’s pattern since late 2012. Is it safe to keep buying the dips this late in the game?

Baby with the Bath Water

In 2013, declining market volume was a popular topic of discussion among market analysts.

The market was rising, but volume was not, and that was worrisome to long-time market pros.  That condition continues through today.

Some analysts have dismissed the declining volume data though.  Since the market continues to move higher, they assume declining volume no longer matters.

But when you see dark clouds rolling in, the wind picking up, and cows lying down in the fields, but no rain is falling, does that mean you leave your umbrella at home and dismiss the clouds and wind (and cows) as unimportant?

Shoving aside diminishing trading volume as non-eventful because the market is still rising would be a similar error in logic in my opinion.

Yes, the market (NYSEARCA:UPRO) is rising. But volume is waning, and historically that has not been associated with strong bull markets.

Why Volume Matters

The “big boys” (also known as institutional investors like mutual funds and hedge funds) operate with big numbers, and big numbers mean big volume.  A few thousand shares here and there is nothing. But if you are big and want to buy something you must buy a boatload of shares, millions per position.

Rising volume is associated with the big boys buying and selling, so when the market is rising on increasing volume it is assumed the big money, also typically considered the “smart money”, is buying.  When the market is rising while volume is declining the implication is the big money is not the one buying, more likely slowly exiting positions.

The chart below shows the Dow Jones Industrial Average’s (NYSEARCA:DIA) price along with volume since 1980.  Volume rose with price until 2007, spiked significantly higher in the ’08 financial crisis (a normal volume pattern during crisis), flat-lined into 2011, and has fallen ever since, suggesting since 2012 the smart money was not driving the markets higher in price.


Throughout the hundred years of U.S. stock market history, bull markets looked more like the 80’s, 90’s, and ‘00s as rising volume accompanied rising prices as the big boys sent shares higher and more and more money flowed into equities as interest increasingly piqued.

Since 2012, though, volume has been dropping off a cliff as the big boys it seems are not following this market higher by buying more shares.  If they were, volume would be rising as the big money needed to buy more and more shares entered the markets.  Volume suggests that is not happening.

Other Breadth Warnings

Breadth can be helpful as a warning sign on the shorter term as well.  In our 1/20 Technical Forecast which we publish twice each week we noticed a similar breadth warning concerning individual stocks.  In that update for our subscribers we warned,

“The % of stocks above their 50 day moving averages peaked in February and again in May along with new all time highs.  Since then though, the peaks have not shown as much participation and display a market that makes new all time highs, but on the backs of less and less stocks.  A breakdown below 60% accompanied all the market pullbacks in 2013 and again will be a warning that a majority of stocks are nearing downtrends and a larger selloff is likely.”

A decline below 60% occurred later that week, on Thursday, 1/23.  The markets (NYSEARCA:IWM) then fell another 3% that following Friday and into the following week.  We were able to warn subscribers of the risks in the market due to declining participation in the uptrend as a full 40% of stocks fell below their 50 day moving averages, constituting downtrends.  (For more information on another indicator we are following see my article on the put/call ratio and how it also helped warn our subscribers of the current market pullback.)

WATCH:  “Apple – A Great 2014 Short Setup” (Our video from early January, just days before Apple’s 8% selloff)

More Warning Signs

But these are not the only indicators painting breadth warning signs.  In a recent Technical Forecast I pointed out that the number of stocks making new 52 week highs is very low compared to historical market (NYSEARCA:DOG) rallies.  Even worse, that trend in new highs has been declining over the last eight months in a frightening similar way that led to the 2007 market peak.

Like the market’s current breadth situation, the S&P’s (NYSEARCA:SDS) number of stocks making new 52 week highs in 2007 occurred in February of that year, at just over 100 companies.  The market’s peak in price didn’t occur until 8 months later, in October 2007, as the number of companies making new 52 week highs continued to deteriorate with each successive new price peak, culminating at only 60 companies at the 2007 major market top.

Today breadth indicators are painting a similar profile.  The S&P’s (NYSEARCA:SSO) number of 52 week highs peaked in May of 2013 with almost 200 companies confirming the S&P’s new all time price high.  Also eight months later, in the market’s latest peak, that number has fallen to under 100 companies.

Not only has volume been declining significantly even as the market rises, but fewer and fewer companies are participating in the uptrend. That means the market is relying on fewer companies for leadership.

For more on the eerily similar breadth conditions today compared to 2007 including charts and detailed analysis checkout ETFguide’s Technical Forecast.  We specialize in using technical and sentiment analysis to keep investors on the right side of the market with common sense analysis and actionable trades.

Follow us on Twitter @ ETFguide

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  1. FRANK says:

    Other than to get out of the stock market,is there a way that we can protect ourselves or position our portfolios properly to actually make money during the next devastating fall of the market that many are now starting to predict will happen this year 2014 or sometime next year 2015? Some are talking about getting into certain ETF’s and Securities’ that do well when the stock market falls.

    • Ronald Delegge says:

      Hi Frank,
      One of the simplest ways for people to protect themselves – aside from buying inverse or short ETFs is 1) to make sure cash is part of your investment portfolio’s mix and 2) to use stop loss orders.

      Regarding cash…it will cushion a portfolio when the house of cards comes crashing down and it will allow the investor to make opportunistic purchases by buying beaten down investments when others are selling. If you’re always fully invested, you don’t have that kind of flexibility.

      Regarding stop loss orders…they are designed to limit your losses and most of the time that’s what they will do. They also help you to have trading discipline.

      For our paid subscribers, we offer a neatly organized listing of all the 1x, 2x, and 3x long/short ETFs. It’s very helpful.

  2. noah says:

    Buy VXX.

1 Pings/Trackbacks for "Higher Stock Prices on Declining Volume, a Major Red Flag?"
  1. […] the rally is an eerily similar pattern to the pre-crash stock market of 2007. (See the article “Higher Stock Prices on Declining Volume, a Major Red Flag?” by my colleague Chad […]

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