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Why Low Volume May Not Be Bearish

Low volume may not be as bearish as it seems.

Trading desks have been bemoaning the lack of volume lately, as stocks still drift quietly higher, adding to the market's 60-plus percent move since last March.

"There seems like there's no true conviction," said one trader, voicing a widespread concern.

New York Stock Exchange consolidated average daily volume dipped to a level of about 4.7 billion shares in February, about 8 percent below January's level. With the exception of last week, March is even weaker, with average daily volume of about 4.3 billion.

"There are a lot of things that are Wall Street codes that they take for granted as being fact, and it may not be," said Jeff deGraaf, head of technical research at ISI Group.

"I hear the bear argument try to latch on to volume..my point being that's a bitter pill to swallow. I can't use this as a jumping-off point to be bearish," he said.

DeGraaf once did a study where he looked back at previous bull runs since the 1960s, and with the exception of 1982, they started on relatively light volume.

"When volume starts to really rise, it was generally the point where the trend is about to change," he said in a telephone interview.

"2003 had a very weak volume profile to it. '91 generally had a pretty lackluster volume profile, other than the first couple days, and it still went up. The one that stands out to people is 1982, when you're coming out of the long bear market. You had huge volumes in August and September," he said.

In February 2009, average daily volume was 6.3 billion, and NYSE consolidated daily volume jumped to 7.3 billion shares as the market hit bottom in March 2009. Volume leveled off last summer to about 5 to 5.5 billion daily, before dropping to 4.4 billion at the end of the year. Volume picked up in January, to 5.1 billion shares before trailing off in February, around the President's Day holidays.

Last week's volume was above current trend, as unusually heavy trading in Citigroup contributed well over a billion shares daily from Tuesday to Friday, bringing the four-day average to 5.26 billion shares.

A spike in volume, however, can signal a negative: "When volume is consistently above the intermediate term average, that's when you start to worry about the reversal," DeGraaf said.

"We had lots of volume in a capitulative environment. What you want to be on guard for is the bear capitulation at this point. It's basically crescendos that you have to be careful of," he said.

"...As volumes increase substantially it becomes more of an indication that you're dragging the last holdouts into the market."

DeGraaf said he did the study a while back while at Lehman Brothers, where he looked across a universe of individual stocks as well.

"The reality was we could not prove that volume was an important factor or critical factor even when we looked at a breakout in individual stocks," he said. "...Price was a more important indicator."

DeGraaf said he sees stocks continuing higher, and he agrees with many that the market is overbought, but it's a "good overbought."

He said the current environment is bullish because there are signals confirming the strength, including the fact that 20-day highs have expanded and breath is making a new high. "I'm in the camp that we're grinding higher," he said.

"What we didn't have four months ago, while we had a good trend, was that we didn't have any momentum," he said.

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