Volume is a measure of how much of a given financial asset has been traded in a given period of time, or how many times the asset has been bought or sold over a particular span. It is a very powerful tool but is often overlooked because it is such a simple indicator. Volume information can be found just about anywhere, but few traders or investors know how to use this information to increase their profits and minimize risk.:
For all buyers in the market, there needs to be someone who sells them the shares they bought in order to have a trade, just as there must be a buyer in order for a seller to get rid of his or her shares. This battle between buyers and sellers for the best price in all different time frames creates short-term price movement while longer-term technical and fundamental factors play out. Using volume to analyze stocks (or any financial asset) can bolster profits and also reduce risk.
Basic Guidelines for Using Volume
When analyzing volume, there are guidelines we can use to determine the strength or weakness of a move. As traders, we are more inclined to join strong moves and take no part in moves that show weakness – or we may even watch for an entry in the opposite direction of a weak move. These guidelines do not hold true in all situations, but they are a good general aid in trading decision
Volume and Market Interest
A rising market should see rising volume. Buyers require increasing numbers and increasing enthusiasm in order to keep pushing prices higher. Increasing price and decreasing volume show lack of interest, and this is a warning of a potential reversal. This can be hard to wrap your mind around, but the simple fact is that a price drop (or rise) on little volume is not a strong signal. A price drop (or rise) on large volume is a stronger signal that something in the stock has fundamentally changed.
Exhaustion Moves and Volume
In a rising or falling market, we can see exhaustion moves. These are generally sharp moves in price combined with a sharp increase in volume, which signal the potential end of a trend. Participants who waited and are afraid of missing more of the move pile in at market tops, exhausting the number of buyers. At a market bottom, falling prices eventually force out large numbers of traders, resulting in volatility and increased volume. We will see a decrease in volume after the spike in these situations, but how volume continues to play out over the next days, weeks and months can be analyzed using the other volume guidelines.
Volume can be very useful in identifying bullish signs. For example, imagine volume increases on a price decline and then the price moves higher, followed by a move back lower. If the price on the move back lower stays higher than the previous low and volume is diminished on the second decline, then this is usually interpreted as a bullish sign.
Volume and Price Reversals
After a long price move higher or lower, if the price begins to range with little price movement and heavy volume, this often indicates a reversa
Volume and Breakouts vs. False Breakouts
On the initial breakout from a range or other chart pattern, a rise in volume indicates strength in the move. Little change in volume or declining volume on a breakout indicates lack of interest and a higher probability for a false breakout. :
Volume should be looked at relative to recent history. Comparing today to volume 50 years ago provides irrelevant data. The more recent the data sets, the more relevant they are likely to be.
Volume indicators are mathematical formulas that are visually represented in most commonly used charting platforms. Each indicator uses a slightly different formula, and therefore, traders should find the indicator that works best for their particular market approach. Indicators are not required, but they can aid in the trading decision process. There are many volume indicators, and the following provides a sampling of how several of them can be used..