Market drought offers little respite to traders

YOU can almost see tumbleweed rolling down Threadneedle Street, as trading volumes drop over the summer months every year. But this year is different. We are not just seeing a drop in the short-term, but also in longer-term volumes. And these falls pose a risk for traders who don’t properly manage their risk exposures.

“Traders should be wary of low volumes. They often lead to spikes in volatility and sharp moves that could leave them in a nasty position,” says Angus Campbell, head of market analysis at Capital Spreads. “The rule of thumb is that, if there’s a big move against a trend, complimented with high volumes, it’s a good indication that a change in that trend is about to occur – especially if prior sessions had seen volumes gradually falling.”

In the short term, low trading volume is being driven (or not) by the usual seasonal drop-offs in August trading, as well as by patterns dictated by markets dependent on policy announcements (for example, traders sitting on their hands in advance of European Central Bank and Fed announcements).

But the drop off in volume is part of a broader, more long-term drop in trading. Despite a three year equities bull market, this year saw the lowest volume of cash equity trading since December 2007. This is partly due to a change in trends – though cash equities have seen a big drop, options markets have seen increased volumes every year for nine years, with investors lured by increased volumes and the protection offered by derivatives. But the drop off in equity volumes has another explanation – having been hammered by two market crashes in the last decade, investors, particularly retail investors, are wary of getting their fingers burned again.

And the seasonal drop isn’t just hitting those traders caught out by bigger price movements. When NYSE Euronext reported its second quarter earnings yesterday, with earnings of $0.51 per share slimly beating the $0.50 consensus expectation, it reported a big drop in trading volumes. Average US daily volumes were down 12 per cent, year-on-year, for the second quarter. This follows first quarter results, showing a 23 per cent drop, year-on-year, for 2012. Though falls in European transactions have been lower, they have fallen nonetheless – the NYX’s average daily volume in cash trading fell in the first half of 2012.

Though the NYSE has other arms to its operations, transaction and clearing fees make up the bulk of its revenues. And it’s not just the NYSE that has been squeezed by lower trading volumes – the Nasdaq reported a first quarter fall in year-on-year cash trading equity revenues of almost 15 per cent, with another drop of 11.9 per cent in the second quarter. The story was the same at the CME group which reported a second quarter fall in trading, with 12.4m contracts exchange on the CME in the second quarter, down from 13.5m in the second quarter of 2011.

Though exchanges feeling the pinch, due to a fall off in fees from trade clearing, isn’t really your problem, dropping volumes can be if you’re not careful. “Low volumes are one of the bugbears for those trading during the summer months,” says Christopher Beauchamp, market analyst at IG Markets. “The same cautionary principles as with other times of high volatility apply, namely keeping stops wide and ensuring that you don’t become over-committed. With sufficient margin, traders will be better placed to ride out the swings that are commonplace during August. Wider stops prevent positions from being eliminated unnecessarily.”