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Financially Friendly

The Myth of Turnover

We sometimes heard the financial commentators on TV or radio say that a low ‘turnover’ in the stock market indicates there’s no strong force to push the market up or down further. This should be taken with skepticism as the turnover is far from an accurate measurement of the direction the market will move.

Turnover is defined as the volume of transactions multiplied by the prices. For example, if 1 million shares of HSBC stock are transacted at the average price of $53, then the turnover becomes $53 million. The larger the number of transactions, the higher the turnover will be and so will be the variations of the transacted prices. The market turnover of a specified period is the aggregate of the turnovers of all the stocks traded over the same period.

If Buyer A is optimistic about HSBC stock, then he can buy 400 shares from the market at $53 per share. If nobody is willing to sell at $53, he can up his bid to, say, $53.1. If there’s still no willing seller, then he can try higher—$53.2, and so on. If finally, a seller is willing to sell at $53.2 and the transaction is completed, then the turnover becomes $21,280. This amount of turnover does not imply that the HSBC stock can go higher or lower but merely a mutual agreement between a buyer and a seller to transact 400 HSBC shares at $53.2 which is higher than its closing price of $53 the day before.

If Buyer A is unreservedly optimistic about HSBC stock, then he can try to buy 4 million shares at $53.2 but, in this case, there may not be enough sellers in the market at this price. Buyer A needs to raise the price again, and may eventually have bought all 4 million shares in various tranches at prices of $53.3, $53.4, ….all the way to the closing price of $56 with an average price at $55. The turnover then becomes $220 million. Can we conclude that such a high turnover means that the price of HSBC will go even higher than the closing price of $56? Other than a result of the meeting of the minds between optimistic buyer(s) and pessimistic seller(s), the turnover figure is hardly an indication of the future direction of the price of the stock concerned.

Then there are issues of hidden agenda as well. Why would the financial pundits be willing to appear on TV or radio to share invaluable investment tips for a modest fee? Many of them are from the ‘seller’ side or brokerage houses. The volume of transactions and turnovers have direct bearing on the amount of their commission income.

This article was originally published in No. 481, Newsletter in Aug 2016.

investments finance