'Don't short a dull tape' – Old Wall Street adage may explain the stock market's comeback

Traders work on the floor at the New York Stock Exchange.

Brendan McDermid | Reuters

The stock market's rally in the face of disappearing trading volumes brings to mind an old Wall Street adage: "Don't short a dull tape."

Traders know better than to bet against a stock in this kind of slow environment and that reluctance could mean this comeback isn't all it's cracked up to be. Stocks may have to reckon with the bears again when traders return from the beach in September.

When a stock has low trading volume, its price can rise significantly based on only slightly good news, said Roberto Friedlander, the head of Energy Trading at Seaport Global Securities. This puts short sellers — traders who hold positions that benefit from a stock falling — in a bind.

"You risk really getting squeezed higher on any kind of sideways to slightly positive data points," said the trader, who used the saying in a note to clients this morning.

Trading in the SPDR S&P 500 ETF averaged about 52.6 million shares on Monday and Tuesday, roughly 31% lower than the average volume of the last 30 days.  The lower volume holds across the broader U.S. market as well, with composite trading volume down more than 20% on Tuesday compared with the 50-day average. Wednesday's trading was on pace to be just as slow.

Meanwhile the Dow Jones Industrial Average rocketed more than 200 points higher on Wednesday, bringing its gain over the last five days to nearly 3%. Stocks fell on Tuesday into the close, but then quickly rebounded in the next session.

"Any pullback in the market or pullback in certain subsectors would just be an excuse and cause short sellers to cover into any pockets of weakness, which in essence would put an underlying bid to the market," Friedlander said.

Contrast that with earlier last week when the main yield curve briefly inverted, an event many see as a reliable recession indicator. On the day the yield curve briefly inverted, more than 135 million shares of the SPDR S&P 500 were traded in one day. 

Peter Boockvar, chief investment officer at Bleakley Advisory Group, said it may be true that low trading volume makes life difficult for shorts, but added that the news flow is unpredictable and could keep markets volatile. He pointed to uncertainty around trade, where a new batch of tariffs are scheduled to hit on Sept. 1, as having the potential to move markets.

"Considering the volatility we've seen in the markets in August ... just because people aren't physically in their offices and volumes may be low, you can be sure that everyone's checking their cell phones every five minutes," Boockvar said.

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