Stock volume is a measure of the amount of a particular financial asset that has been traded over a period of time. For stocks, volume is determined by the number of shares that are traded.
Futures and options volume is based on the number of contracts that have changed hands. Traders rely on volume to determine liquidity and combine changes in volume with technical indicators to make trading decisions.
Observing volume patterns over time can aid in determining the conviction underlying specific stock and market gains and losses. The same holds true for option traders, as trading volume is indicative of an option’s current popularity.
In fact, volume plays a significant role in technical analysis and is a prominent component of several important technical indicators.
KEY POINT
- Volume is the number of shares or contracts traded in a given stock, futures contract, or options contract.
- Volume can indicate market strength, as rising markets with rising volume are typically regarded as robust and healthy.
- When prices fall in tandem with an increase in volume, the downward trend gains strength.
- When prices reach new highs (or no lows) on declining volume, a reversal may be imminent.
- Volume-based charting instruments include On-balance volume (OBV) and the Klinger oscillator.
Using Stock Volume Properly: The Basics
The volume of a trade is typically compared to predetermined standards to ascertain the relative strength of a given price change. Traders tend to participate in uptrends and ignore downtrends, or even wait for an entry in the opposite direction of a downtrend.
While these rules won’t save you every time you go to make a trade, they can serve as a general guideline.
1. Confirmation of the Trend
A rising market should see volume increase. The price of an item can only rise so far before buyers lose interest or enthusiasm. An indication of a possible reversal would be a rise in price accompanied by a drop in volume.
Even though it’s not intuitive, a price change on low volume doesn’t necessarily mean anything. Large price changes (in either direction) on high volume tend to indicate significant fundamental shifts in the underlying stock.
2. Exhaustion Moves and Volume
We can observe exhaustion moves in both up and down markets. Indicative of the possible end of a trend, these are price swings that are both large in magnitude and accompanying in volume.
Waiting participants who are afraid of missing out on the rest of the move flood the market just as it is peaking, driving up prices and driving away potential buyers.
At the bottom of a market, when prices are falling rapidly, many investors are forced to sell their positions, which increases volatility and volume.
In these cases, volume will fall off after an initial surge, but the subsequent days, weeks, and months can be analyzed using the other volume standards.
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3. Bullish Indications
Bearish signs can sometimes be picked up on by looking at volume. Take the hypothetical case of an uptick in volume alongside a decline in price, followed by a rise in price and a subsequent decline.
Assuming the volume on the second decline is lower than the first, and the price doesn’t drop below the prior low, this is taken as a bullish signal.
4. Volume and Price Reversals
Following a sustained up or downtrend, a reversal may be in the works if prices settle into a trading range with little volatility but high volume.
5. Volume and Breakouts vs. False Breakouts
Strength in a move is indicated by a rise in volume upon the initial breakout from a range or other chart pattern. Any breakout that sees little volume movement or declining volume is more likely to be a false breakout.
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6. Stock Volume History
Recent trends in volume are more informative than longer-term averages. It’s possible that if we compare volumes now to volumes 50 years ago, we’ll get misleading results. Newer data sets are better because they reflect current conditions.
Stay tunes for our next article on how to optimize your trading using stock volume.
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