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A Look at NYSE to Nasdaq Volume


This could be just another false signal...


A few weeks ago, we took a look at volume penny stocks traded over the counter. While a good indication of speculative fervor (or lack thereof), one glaring weakness in that data is its delay in reporting and irregular schedule.

To get around that, we can look at an alternate measure that is available in near real-time and can be just as effective.

Today we're taking a look at the ratio of NYSE to Nasdaq volume.

What is it?

The ratio of NYSE to Nasdaq volume is just as it sounds – total volume in all NYSE listed stocks divided by total volume in all stocks traded on the Nasdaq.

Because most "blue-chip" stocks choose (or used to choose) to be listed on the NYSE, most of the stodgy old-school equities can be found there. Young, relatively speculative companies sometimes don't meet the listing requirements of the NYSE, or just choose not to list there, and so the Nasdaq is littered with more upstart stocks that often have a focus on technology.

Therefore, when we take a ratio of volume at the NYSE versus Nasdaq, what we're really looking at is the preference of investors to concentrate on "safer," more established firms versus speculative ones. The higher the ratio, the more investors appear to be avoiding risk. Once the ratio hits an extreme, we often see the broader market head higher (and vice versa for very low ratios).

Why should we follow it?

While it would be overkill, it would be easy for anyone interested enough to follow this ratio on a real-time basis throughout the day. There is no real delay, and the data is freely available at any number of quote vendors and web sites. It's exceedingly easy to calculate, and it's not mandatory to make any adjustments – anyone with a pencil and paper can follow the ratio on any time frame they wish.

The difference in market performance after opposite extremes is notable. Over the past 20 years, when the ratio was at its highest levels (meaning investors had been concentrating on "safe" issues and were overly risk-averse), the future three-month return in the S&P 500 was +5.2%, more than 71% of days were positive, and the average maximum gain was more than twice the average maximum decline.

On the other hand, when the ratio was very low (suggesting investors were too eager to get involved with speculative stocks), the return in the S&P a quarter in the future was +2.1% with less than 60% positive, and the average max gain was equal to the average drawdown. That's not disastrous by any means (it's about on a par with a random return), but several of the largest declines of the past two decades were preceded by a low ratio.

What are the challenges in using it?

Obviously the ratio is not perfect – there have been several false signals over the years. The all-time low was in August 1995, yet not only did equities not fall apart afterwards, they rocketed ahead and never really looked back.

There are also trends in the data, so it's best to de-trend both NYSE and Nasdaq volume somehow. That's what I've done in the chart below, and it helps us compare recent readings with ones from years ago when volume patterns were different.

What does it look like?

What's it suggesting now?

The highest point on the chart, last October, highlights a time when investors were extremely risk-averse, and true to form we saw a healthy rally in the weeks following.

A couple of weeks ago, this ratio reached its lowest point since early January 2005. I've highlighted the other dives lower in the ratio, and for the most part the S&P 500 stumbled going forward after the others. This confirms the data I showed a few weeks ago regarding penny stock volume, and suggests that investors may have become too lenient in their risk tolerance, which has often caused some trouble in equity land.

I don't put as much weight on low readings in the ratio as I do in extremely high ones, so this isn't a "sell everything" kind of signal, but it has preceded enough nasty declines to be on our radar.
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