Volume is an essential part of stock trading analysis. It shows current trends, buyer and seller sentiment, and which company shares are more liquid than others. This number changes wildly as crucial information comes in and savvy traders analyze.
If you’ve been investing or have ever looked for a new company to get into, you’ve probably seen volume before. But what is “volume” in stocks, and how should it affect your decisions?
The Meaning of Stock Volume
In essence, stock volume is the total number of times a security has changed hands over a set amount of time. This number gets estimated throughout the day, sometimes hourly, and at the close of the market. The precise final number only gets reported the following day.
Since prices often change in correlation with higher volumes, many traders also keep track of the tick volume or how often the contract’s price changes. Ultimately, the volume gives investors a good look at a market’s overall activity and liquidity.
Higher trade volumes are attractive for investors. They indicate many people are buying and selling a specific company, so connecting a sale should be quick and easy. On the other hand, low volumes could be a sign of little interest, making buying or offloading a specific security somewhat cumbersome.
How Does Stock Volume Work?
The stock volume is quantified by how many shares are bought and sold between market open and market close. Many of the same shares may be traded back and forth on the same day at different prices, and each transaction gets counted towards the total volume.
Stock trading volume should not be confused with dollar volume, which represents the aggregate value of the traded shares. For example, if a particular stock has a stock volume of 100,000 shares at $5 per share, the dollar volume would be $500,000.
Volume Defines a Stock’s Liquidity
When researching a stock, you can use the volume to determine how difficult it may be to get rid of your shares should you decide to sell them.
Stocks with lower volumes tend to be harder to get rid of in large numbers. Sometimes transactions take longer to connect, or sellers end up letting shares go below market value at a discount. That can lead to a gap between the ask price (the price set by sellers) and the bid price (the amount buyers are willing to pay), which can increase volatility.
On the contrary, stocks with a higher volume tend to be easier and faster to sell at market value. Think of it like desired toys around the holidays flying off the shelves.
Using Stock Volume When Trading
Volume can be an excellent way to identify the strength of a market. Here are a few ways to utilize this number to your benefit:
Finding and Confirming Trends
Simply put, a rising market usually experiences rising volumes. In order to maintain the enthusiasm of prices moving upward, investors will be buying and selling shares in larger quantities.
Essentially, a drop or rise in price on little volume is not considered a strong indicator. If prices increase while volume decreases, this may indicate a reversal soon. However, this same price rise or drop in a large volume is a much stronger indicator that something noteworthy has changed.
Look at Volume History
The volume history of a stock is a key technical indicator in the overall analysis of a stock. Analyzing the patterns of stock volumes over time can help to get a good feel for rises and drops in particular stocks and markets.
That may be especially true for options traders since volume is a strong indicator of current interest in a particular option contract.
Exhaustion Moves Show People’s Limits
In a declining market, you can see exhaustion moves. These are typically sharp moves in price correlated with sharp volume increases, indicating the probable end of a trend.
If you get FOMO (fear of missing out) for action at the top, you may end up in a pool of exhausted buyers. Alternately, at the market bottom, the declining prices eventually force a fair amount of traders to sell, resulting in increased volatility and volume. There will usually be a decrease in volume after the initial spike in these scenarios.
Identifying Bullish or Bearish Signals Through Volume
It gets a bit tricky, but you can use stock trading volume to identify bullish and bearish signs.
For example, say volume increases on a price decline. Afterward, the price moves higher but is followed by another dip. If the volume falls off and the price on that second dip doesn’t fall below the first dip, it is typically regarded as a bullish sign.
Early Indication of Reversals
After a longer price move in one direction, you might see the volume buildup, and the price change starts to slow down. This pattern may indicate that a reversal is on the horizon, and prices could change their direction.
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What Is Average Volume in Stocks?
The average volume of stocks is the sum of all daily volumes over a period of time divided by the number of days. Typically, this number gets calculated over six months to come up with a much more stable average, but let’s look at a simple example for a single week using the table below:
|Day of the Week||XYZ Stock Volume|
To find the average daily volume for this week, we would add the volumes for all five days together and divide the total by five days. That gives us an average daily volume of 7,530.
Mon 2,500 + Tue 13,600 + Wed 3,000 + Thu 8,750 + Fri 9,800 = 37,650 total volume for the week
37,650 total volume / 5 days = 7,530 average daily volume
This number is an important metric used by traders because both high and low volumes attract various types of prospective investors. Most traders look for higher daily averages during their analysis since that makes getting in and out of positions easier down the road.
So, What’s a Good Average Daily Stock Volume?
A good average daily trading volume (ADTV) varies from person to person and company to company. The specific indicators you analyze will also determine what a good ADTV is and if the asset will be a good addition to your portfolio.
Higher sustained trading volume tends to be over 500,000 shares a day and equals more liquidity, which, as we’ve mentioned, most investors prefer. But perhaps the best ADTV is a stable one because when the number rises or falls sharply, it may indicate a noteworthy change in how investors value an asset.
If a breakout begins, an increase in volume can confirm that breakout. In contrast, a sudden lack of volume may indicate that the breakout will fail.
Most Popular Stock Volume Indicators
Have you ever heard of The Chaiken Money Flow, Klinger Oscillator, and Money Flow Index? These volume indicators use various mathematical formulas to show something a little different about a stock volume.
These and other popular stock volume indicators can help clarify your final decision. Let’s take a look at the top three most common ones:
On Balance Indicator
On-balance volume (OBV) is an effective indicator where volume gets added when the market is higher or subtracted when the market finishes lower. The result is a running total that shows what stocks are being accumulated.
Often times this metric gets used for finding contrast. For example, the price may increase, but the volume increases slower than expected.
Accumulation and Distribution Indicator
The accumulation and distribution indicator uses volume and price to give insight into how weak or strong a trend is.
Suppose a stock price is rising, but the indicator is dropping. In that case, the buying volume (accumulation) might not be enough to support the inflated price, and a drop may be on the horizon.
Relative Strength Index (RSI)
The RSI is an indicator that measures momentum via the speed and magnitude of price changes.
It looks at overvalued and undervalued conditions and helps identify securities that can potentially be primed for reversals. Many investors look to this metric as a signal of when to buy or sell.
Start Monitoring The Volume of Companies on Your Watch List
Volume can be a fantastic way to study trends and find new liquid companies to buy. Depending on the depth of analysis you’re doing, indicators based on volume are significant to help you make your final decisions.
Though volume analysis is not an exact science, it can be a handy tool for savvy investors to analyze for more costly trades.
StockMarketEye software makes tracking volume straightforward with easy-to-read charts and graphs. There is no learning curve to overcome, allowing you to immediately begin analyzing stocks more accurately. Sign up for a trial today to get started!