Trading volume on the U.S. stock exchanges has been flat out lousy over the course of 2010, and has been even worse in recent months. This may not matter to most Fools who aren't day traders or making changes to their equity portfolio daily. However, it does matter if you own stock in some of the banks who rely on trading to generate big profits.

A warning sign
Just last week investment banking firm Jefferies (NYSE: JEF) announced that third-quarter revenues have fallen from $700 million in the previous year to $520 million this year. This 26% drop is no small potatoes even for a large financial firm such as Jefferies. What's more is equity trading, which can be looked at as a sign of investor confidence, was down about 40% from the previous quarter. CEO Richard Handler said, "Trading volumes across the board were painfully slow during the months of June, July, and August. The normal seasonal slowdown was exacerbated by continued concerns over the state of the global economy."

Yikes! That is not good for a firm that has been feverishly hiring employees over the past year, and speaking loudly about an improving profit picture for investment banks.  

Big banks also feeling the pinch
When the large investment banks begin reporting third-quarter results, many analysts and commentators are looking for a large slowdown in revenue because of the anemic amount of trading volume this summer.  And these banks are just starting to tip their hat.

Just this week, it was reported that Morgan Stanley (NYSE: MS) is going to implement a hiring freeze that will last until at least the end of the year. This followed a recent announcement that Bank of America would be laying off up to 400 employees in its global banking and markets division. The slowdown is also affecting companies' global operations as Credit Suisse (NYSE: CS) and Barclays (NYSE: BCS) are in the middle of continued layoffs.

Fox Business Network commentator Charlie Gasparino, who first reported the Morgan Stanley news, said, "A profit drought has forced every major bank and financial firm to reassess hiring, and bonuses levels, for 2010, with Bank of America emerging as the first firm to institute layoffs. Bank of America is cutting staff in its capital markets group by as much as 5 percent amid a sharp decline in trading revenue at the big bank."

According to famed financial analyst Meredith Whitney, this is just the beginning of an industrywide slowdown. Whitney is extremely bearish on the near-term potential for revenue growth at investment banks and estimates that there will be 80,000 job losses in the next 18 months.

The Foolish bottom line
It wasn't too long ago commentators were talking about flawless quarters for these banks in which they would turn a profit on every single trading day. In the first quarter of this year, JPMorgan (NYSE: JPM), Goldman Sachs (NYSE: GS), Citigroup (NYSE: C), and Bank of America reported not one day of trading losses. However, throw in a flash crash or two, or maybe it's the 20 consecutive weeks of equity outflows from domestic mutual equity funds averaging $3.5 billion a week, and you can see the money start to dry up fast.

The days of investment banks bringing home huge sales and trading profits seems to be in the rearview in the coming months and years. Investor confidence has clearly been shaken, and it will take time come back. The success and revenue growth that these financial institutions experience will in large part depend on management diversifying into more traditional investment banking services. As the economy improves, there will be more M&A advisory, underwriting, and deal-making prowess necessary. These firms will be battling for this business, while also hoping investor confidence in financial markets returns sooner rather than later. But, as we all know, hope is not a business plan.

Andrew Bond owns no shares in the companies listed. Try any of our Foolish newsletters today, free for 30 days. True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. The Fool has a disclosure policy.