By Andrew Snyder, Editor-in-Chief, The Oxford Club
Here’s a trick that will make you a smarter, more profitable investor. It’s simple, and the data is already in front of you. Yet, the vast majority of investors pay no attention to it...
Think of this simple metric as a popularity index. The higher the volume goes, the more people like a stock. And the more folks who like a stock... the higher its price will go.
Let’s take our minds on a journey. Let’s go to a used car lot on a busy Saturday afternoon...
We meander around a bit, looking at the stickers on the windows, pressing our foreheads and hands to the glass as we take a peek inside.
As we duck so the salesman doesn’t see us, we worry there are too many to choose from. We’ll never know what’s a good price or which car is better than the others.
But then, we see a line forming to look at a shiny white car near the back of the lot.
What do they know that we don’t?
The salesman sees it, too. He runs his fingers through his slicked-back hair and gets ready to make a sale... a high-priced sale.
Volume on the stock market is not all that different from a line at the car lot. It tells us which stocks are popular and which are not.
But unlike a car lot where sales are private, the stock market lets us see who’s buying (at least, if they’re big buyers), how many shares they’re buying, and how much they’re paying.
To see why that’s important, imagine if each person in line to look at that car had a label on their shirt.
Some would say “tire kicker,” others would say “I need a car for my 16-year-old daughter.” A couple might say “I buy and sell for a living.”
It would tell us a lot about that car. After all, if a bunch of pros are in line, we know there’s something special about that car... Something has their attention.
On the other hand, if it’s a bunch of middle-aged guys looking to buy cars for their daughters, they may be attracted to its fuel-sipping engine... and its tiny back seat.
By knowing who’s doing the buying, we can tell a lot about the car.
It’s the same situation with stocks.
Let me show you.
Running a quick-and-dirty volume screen, we see that Methanex (NASDAQ:MEOH) saw its trading volume spike by more than four times its average daily volume this week.
In other words, there’s a line forming to take this car for a test drive.
With some digging, we learn the stock has Wall Street’s equivalent of some extra horsepower under the hood that wasn’t on the original sticker.
The methanol supplier is getting lots of attention from buyers as its earnings continue to seriously outpace expectations.
After the news that profits were three times what was expected, folks are lining up for a test drive. We can’t blame them.
But should you hop in line? Longtime readers know the answer.
Joining the herd usually leads to slaughter.
Instead, here are my three rules for tracking volume:
- Always ask who is buying and why - retail investors, pension funds, insiders, etc. There’s almost always an obvious reason for a volume spike - earnings reports, product release, etc. If the reason isn’t clear, don’t walk away. It’s often a good sign of positive news to come.
- Insider volume counts the most. This is vital and won’t show up on a simple volume screen. Instead, you need to track SEC Form 4 submissions. If insiders are loading up, don’t wait. Buy now. It’s the equivalent of the manager of the car lot jumping in the driver’s seat.
- If the price spikes as volume soars, wait for it to drop. As the initial rush wanes, the price will drop. Often, waiting until the price retraces at least 25% of its spike is a smart move. In other words, if a volume spike sends a stock from $10 to $15, wait until it’s at $13.75 or lower to make your move.
A good example of this comes, once again, from Methanex.
In late September, a volume spike of more than four times average trading volume sent shares from $30.84 to $35.76 - a 15% move. Three trading days later, they had dipped, retracing the move by more than 25%.
Shareholders who spotted the volume surge and bought on the subsequent 25% dip are now sitting on shares worth more than $51 - a gain of 45% in less than four months.
It proves that paying attention to volume is vital. It often points the way to big gains to come.
Add the simple metric to your investing toolbox. It will pay off.
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