Traders use volume, which displays the number of shares that have been traded during a particular time period, as a way to assess the significance of changes in a security's price. Volume analysis is viewed as an important tool by many traders because it reflects not just the opinions but the real actions of traders in the marketplace and provides a second piece of information rather than simply analyzing price movement in a different way.
Volume is simply the number of shares traded during a given time period such as a day, week or hour.
The theory behind volume analysis rests in the belief that above average and/or increasing trading volume signals important commitment on behalf of traders and that below average and/or decreasing volume signals a lack of enthusiasm on the part of traders. As a result, many traders view volume as potentially indicative of the true strength behind a price move.
It's important to note that not every large increase or decrease in trading volume will signal something of great significance. The key to utilizing volume analysis in a meaningful way is to consider price action in conjunction with significant movements in trading volume.
Indicator Signals: What Traders Look For
When using volume, traders look for either convergence or divergence to help confirm or deny the possible strength or direction of a trend.
Convergence - Volume that moves in the same direction as price.
Divergence - Volume that moves in the opposite direction from price.
Upside Breakout accompanied by Volume Convergence (Confirmation of Trend Strength)
During uptrends and in sideways markets, price will occasionally run into a resistance level. When price breaks through to the upside above a previous resistance level, the breakout is generally believed to be of greater significance if it is accompanied by above average and/or large volume, as opposed to a breakout that is accompanied by low volume.
Uptrend accompanied by Volume Convergence (Confirmation of Trend Strength)
When an uptrend is confirmed by increasing and/or above average volume it is implied that there is a greater level of investor enthusiasm for that stock or asset and that that enthusiasm may lead to more buying and even higher prices.
When an uptrend is not confirmed by increasing and/or above average volume it is implied that investor enthusiasm is limited. While the security may continue to rise in price, many traders who utilize volume analysis will look for other candidates.
Downside Breakout accompanied by Volume Convergence (Confirmation of Trend Weakness)
During downtrends and in sideways markets, price will occasionally run into a support level. When price breaks through to the downside below a previous support level, the breakout is generally believed to be of greater significance if it is accompanied by above average and/or large volume, as opposed to a breakout that is accompanied by low volume.
Downtrend accompanied by Volume Divergence (Confirmation of Trend Weakness)
When a downtrend is confirmed by increasing and/or above average volume it is implied that there is greater level of investor concern regarding that stock or asset and that that concern may lead to more selling and even lower prices.
When a downtrend uptrend is not confirmed by increasing and/or above average volume it is implied that investor concern is limited. While the security may continue to decline in price, many traders who utilize volume analysis may start to follow the stock and watch for signs of a pickup in price that is accompanied by higher volume.
Volume reflects traders actually taking action in the marketplace and as a result is a very useful measure of investor sentiment. As a rule of thumb, any price breakout or trend that is accompanied by above average volume is considered to be of potentially greater significance than price movements that are not.
Schwab does not recommend the use of technical analysis as a sole means of investment research.
The information here is for general informational purposes only and should not be considered an individualized recommendation or endorsement of any particular security, chart pattern or investment strategy.
Past performance is no guarantee of future results.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.