Here’s the Real Reason Why Stock Market Prices Go Up

Over the past couple of weeks we’d heard stories about the queues forming at bullion dealers.

Our old pal, Diggers & Drillers editor, Dr Alex Cowie had heard first hand from bullion dealers in Melbourne and Sydney about lines forming out the door and down corridors.

Anyway, being a cynical soul, we thought we’d check the scene out ourselves.

Bearing in mind that the last time we turned up at a bullion dealer four months ago, you could swing three cats tied head to tail and still not hit anyone, we were surprised at what we saw…

When we got there just before lunch there were four people ahead of us in the queue.

But by the time we left as the lunch crowd started filing in, there were 19 people waiting, with two others standing at the counter.

The queue was longer at the bullion dealer than it was at the Commonwealth Bank branch on Collins Street.

We certainly now believe the stories about queues the week before as gold slumped more than $200 in just a couple of days.

But we’re not here to talk to you about buying gold or silver bullion. As we mentioned last week, stop over-thinking it and just do it.

However, we do want to look at the impact higher volume has on markets, especially the stock market

Why Volume Isn’t Important

Measuring stock market volume is different to measuring volume at a bullion dealer. For a start, you can’t go somewhere to see people queuing up in a corridor to buy BHP Billion [ASX: BHP] shares or Commonwealth Bank of Australia [ASX: CBA] shares.

But you can of course see the trading volume in another way. That’s by looking at stock charts.

However, the story isn’t straightforward.

For the most part, when you buy shares you’re buying them from someone who’s selling (obviously). They’re selling because they think the price will fall…or at least, won’t rise much.

In other words, the volume of buys going through the market exactly matches the volume of sells. That’s why looking at volume on its own isn’t always a useful indicator (Murray explains more on this in today’s Money Morning Premium).

In fact, if you crunch the numbers you’ll see very little difference between the volume and value traded two years ago to that traded over the past year.

Take Commonwealth Bank shares as an example. Over the past year, $63 billion-worth of CBA shares has changed hands while the share price soared 37%. In the previous year $64.6 billion changed hands while the shares fell 3.1%.

Or look at it another way.

Yesterday, $118.8 million-worth of Commonwealth Bank shares changed hands. Sounds like a lot right? It is, but not compared to CBA’s market capitalisation of $114 billion.

It means yesterday barely 0.1% of the company’s shares changed hands. And yet that small number of trades caused a 1% change in the share price.

That tells you on any given day, regardless of market conditions, or whether it’s a rising market or falling market, most investors prefer to do nothing. And it also tells you that you don’t need increased volume for share prices to rise.

So why do so many people look at trading volumes? Probably because they think more buyers mean higher prices.

But it doesn’t always work that way. Remember, the volume of bought shares has to equal the volume of sold shares.

Stocks to Rise on a Torrent of Optimism?

This is exactly why when we talk about a torrent of cash flooding into the market, we also talk about the need for investors to believe the economy is improving.

A torrent or volume spike on its own won’t be enough to push the market to the record level we predict for 2015. Short-term volume spikes rarely last long. But a torrent of cash and improved investor optimism…well, that’s a different story.

In short, if investors believe the economy will recover and markets deserve to go higher, then investors will pay and demand higher prices, regardless of the volume traded. That is the real key to the market rising further.


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PS. Most novice traders look at two things on stock charts — price and volume. Unfortunately, only one of those is worth looking at. In today’s Money Morning Premium I asked technical trading guru Murray Dawes for his thoughts on trading volume. He told me ‘I would never use it alone as a reason to trade.’ But there is one occasion when he would use it. Click here to upgrade now.

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Money Morning: How the Rich make Money from the Stock Market

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