On Tuesday, I made the following observations on recent price action in the S&P 500 and volume levels:

“The relief in equity markets could be short-lived, however. A tenet of technical analysis is that a move by an asset (commodities, currencies, equities, etc) is considered to be ‘technically strong’ if there is strong volume supporting the move. Such has not been the case. Volume has been lacking behind the recent gains in equity markets in recent days, especially compared to recent averages.”

With minimal price action the past few days, relative to the first few weeks of August, and volume substantially lower, the trend appeared to be holding. The data accumulated thus far on Thursday strengthens the argument.

SP_500_Plummets_as_Volume_Surges_body_Picture_13.png, S&P 500 Plummets as Volume Surges

Prepared by Christopher Vecchio

At the time this article written, volume on the S&P 500 was 751.96 million shares – roughly 30 million less than Wednesday’s volume – and there are still 90 minutes left in the U.S. session. Similarly, the Australian Dollar and the Canadian Dollar are two of the worst performing currencies on the day, down 1.61 percent and 1.00 percent against their American counterpart, respectively.

Updated from August 16, 2011

SP_500_Plummets_as_Volume_Surges_body_Picture_19.png, S&P 500 Plummets as Volume Surges

Prepared by Christopher Vecchio

During the second round of quantitative easing, from November 3, 2010 to June 30, 2011, the S&P 500 traded mostly higher, rising from 1221.06 to 1320.64, as noted in the chart above. Volume was both dense and thin, and the correlation between the S&P 500 and volume was an insignificant -0.14 over the life of the Federal Reserve’s liquidity injections vis-à-vis quantitative easing.

SP_500_Plummets_as_Volume_Surges_body_Picture_22.png, S&P 500 Plummets as Volume Surges

Prepared by Christopher Vecchio

Since July 1, the day after quantitative easing round two ended, a quite different story has unfolded. The S&P 500 has dropped from near 1350 to as far as 1100. Volume, on the other hand, has been steadily increasing, as noted in the chart above. The correlation here, albeit, on a smaller pool of data, is significantly stronger: a -0.88 correlation.

Certainly, this is cause for concern. A brief glance over correlations between currencies, equity market performance and volume suggests necessarily suggests that currency traders maintain cautious optimism towards the riskier assets, especially the long-components of the FX Carry Trade Index.

As David Rodriguez, Quantitative Strategist noted in a report today, “The Australian Dollar’s link to the Dow Jones Industrial Average likewise trades near record-strength, and the AUD/USD remains a speculator’s favorite as a proxy to stocks and commodity prices…Thus if you believe that the DJIA is headed higher, the AUDUSD represents an attractive and more liquid alternative to straight bets on the Dow itself.

I would point out that, like the DJIA, the S&P 500 shares a near-identical correlation with the AUD/USD, while also sharing an equally significant negative correlation (positive with the Loonie) with the USD/CAD. Accordingly, as the data suggests, if volume picks up, the S&P 500 will likely fall, and given their correlations with the S&P 500, the Aussie and the Lonnie will likely fall as well against their American counterpart.

Written by Christopher Vecchio, Currency Analyst

To contact the author of this report, please send inquiries to: cvecchio@dailyfx.com

Follow Christopher Vecchio on Twitter: @CVecchioFX