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Does Light Volume Really Matter?

Light volume: does it matter? I've been asked this question repeatedly in the past few months, and regularly this month as the markets have hit new highs on even lighter volume (even accounting for the holidays). (See the "Fast Money" traders' angle on light volume.)

The short answer is that under traditional technical analysis, light volume as the markets hit new highs is definitely a concern. Combine this with other indicators, like very high levels of complacency (VIX near a multiyear low), low put/call ratios, and high levels of investor bullishness and it's no wonder that many technicians are concerned.

Tom McClellan, editor of the McClellan Market Report, is in the old school and believes that light volume does matter—though it is important to filter out the effects of holidays.

Take a look at the following chart, which plots volume in the Powershares QQQ Trust (the ETF for the Nasdaq 100, one of the largest and most actively traded ETFs) against the volume for that ETF.

As you can see, volume has been dropping even as it has moved to highs in the past several months.

"It was low even before the Christmas slowdown, and is now at a multi-year low," Tom wrote to me.

"The snow and the holiday were certainly part of that, but this is a big message of a market top nonetheless. It is much lower than what we saw last Christmas."

Still, there are others who take note of the light volume, but point out that significant rallies can be sustained on light volume. As an example, they point to the entire fourth quarter, and particularly December. Had you lightened up in October as the rally was gathering steam while volume was not inspiring, you would have missed the main part of this year's rally.

Bottom line: keep an eye on those technicals, but keep an eye on the charts...there is no sign of a rollover yet.

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