Trading Volume and Stock Indices: A Test of Technical Analysis

Abstract

Problem statement: Technical analysis and its emphasis on trading volume has been used to analyze movements in individual stock prices and make investment recommendations to either buy or sell that stock. Little attention has been paid to investigating the relationship between trading volume and various stock indices. Approach: Since stock indices track overall stock market movements, trends in trading volume could be used to forecast future stock market trends. Instead of focusing only on individual stocks, this study will examine movements in major stock markets as a whole. Regression analysis was used to investigate the relationship between trading volume and five popular stock indices using daily data from January, 2000 to June, 2010. A lag of 5 days was used because this represents the prior week of trading volume. The total sample size ranges from 1,534-2,638 to observations. Smaller samples were used to test the investment horizon that explains movements of the indices more completely. Results: The F statistics were significant for samples using 6 and 16 months of data. The F statistic was not significant using a sample of 1 month of data. This is surprising given the short term focus of technical analysis. The results indicate that above-average returns can be achieved using futures, options and exchange traded funds which track these indices. Conclusion: Future research efforts will include out-of-sample forecasting to determine if above-average returns can be achieved. Additional research can be conducted to determine the optimal number of lags for each index.