Today's email included a plausible hypothesis for the volume disconnect (original post below) sent by the VP of Institutional Trading at a major investment company:

Big firms use SPY to hedge risk, primarily in options. Option volumes have fallen recently because of the surge in the overall market.

Clients use options much more frequently when the market is falling than when its rising. Thus dealers haven't been particularly active and aren't using SPY that much to hedge their risk.

Of course that's just a back of the envelope theory, its certainly not definitive. There are probably a few things going on, but it's not some major conspiracy or indicative of a "fake rally."

As this chart illustrates, since the March low, volume in the SPDRs ETF (SPY) has generally moved inversely with price, which does not especially inspire confidence in the rally. Or perhaps we're merely seeing typical summer doldrums.

But here's a recent curiosity: Over the three-year timeframe of the chart, SPY volume has closely tracked the volume of the underlying S&P 500 index. However, during the past month, volume in the two has diverged. Is this a clue of some sort? And if so, about what? Retail versus institutional investors? High-frequency trading? And what can we infer from that S&P 500 volume spike in May?

See this post for more on volume during rallies.