How Does Volume Affect Stocks?
If a stock with a high trading volume is rising, it usually means there is strong buying pressure, as investor demand pushes the stock to higher and higher prices. One the other hand, if the price of a stock with a high trading volume is falling, it suggests that there is a lot of selling pressure.
Different conclusions can usually be drawn from low trading volume. If a stock is rising on low volume, it may simply reflect an absence of sellers. And if a stock is declining on low volume, it might mean there are very few bids.
The most common timeframe to use when talking about volume in stocks is the daily volume. The average daily volume is the average number of shares traded per day over a certain period, often approximately 1 month.
Tip: Volume is the number of shares of a stock that have been transacted over a certain period of time. Volume is usually quoted for a single trading day.
High vs. Low Volume Stock
When considering volume while evaluating a particular stock, investors might want to assess how difficult it could be to dispose of their shares if they decide to sell.
- Stocks with low volumes can be difficult to sell because there may be little buying interest. Additionally, low-volume stocks can be quite volatile because the spread between the ask and bid price tends to be wider.
- Stocks with a high volume and a rising price are generally easier to sell at a desirable price.
When a stock has an unusually high volume, it often means something important is going on with the company, be it related directly to the company development or simply a rumor. High volume could reflect that good or bad news is being disseminated by the market, but not necessarily. It's not always clear why a stock is soaring or plunging.
Tip: If a stock price is plunging on high volume, some contrarian investors may consider buying, but such a strategy can also prove risky. Sometimes a contrarian bet can pay off, but it depends on the company and what's happening with it.
How Volume Is Used In Trading
Volume can be an indication of market strength. Here are several ways one can read and use stock volume.
1. Can Indicate a Stock is Strong for Adding to a Portfolio
When a stock is rising, it indicates strength. Investors can make an assessment of how convicted traders are about a particular stock, or the market in general. High volumes indicate a strong conviction with the direction in which the stock or market is moving. However, volumes are not revealing of the reason for the market trend, so investors will have to research to find out why the trend is occurring.
Investors can use volume information to assist in their determination of whether a stock would be good for their portfolio. For example, a rising stock should bring increasing volumes, indicating a strong bullish conviction. However, if investors see a rising price and declining volume, it might suggest a lack of interest, and a reversal may be just around the corner. In such a scenario, it might not be a good idea to buy that particular stock. Investors who have high conviction about the stock in the long term might want to wait for a pullback before buying it if recent stock price gains were on low volume.
2. Can Indicate If the Market is Exhausted with a Stock
Volume can also be used to determine when the market has gotten exhausted with the direction of a particular stock. When there's a sharp change in the price and a sharp increase in volume, it suggests the trend could be ending. Investors who are afraid of missing out tend to buy high, resulting in a sharp increase in volume. However, when everyone has bought a stock, the security price often stagnates and then falls because the market has exhausted all buyers interested in the stock.
On the other hand, when a stock has bottomed out, many investors have been forced out by the falling price, causing high volumes and increased volatility. Volume then declines after the spike, although it may change again in the long term.
3. Can Indicate If Investors Are Bullish On A Stock
A key bullish indicator is when a stock price has fallen on increasing volume, ahead of a share price rebound, followed by another decline on lower volume. If the stock price doesn't fall below the previous low when it declines the second time, and volume is down during that second decline, it can be a bullish indicator.
Tip: Traders use volume in combination with other indicators to determine market trends and make educated guesses about where a stock price will go next, so that they can determine if it would be good for their portfolio.
Volume as a Technical Indicator
Some investors use volume as a technical indicator when looking at a stock chart. Some examples of technical indicators include the on-balance volume, the volume price trend indicator and the volume relative strength index.
- On-balance volume: a momentum indicator which uses volume flows to predict movements in a stock price. It can help traders determine whether the general market is bullish or bearish on a particular stock.
- Volume price trend indicator: helps investors figure out the direction of a stock and the strength of changes in the price
- Volume relative strength index: measures the speed and change in volume in an attempt to gauge price trend changes.
What's a Good Average Volume for a Stock?
Some may wonder whether a higher trading volumes are good for stocks. There is no clear definition of what a good volume is for stocks. In fact, sometimes volumes may increase for reasons like stock splits or news items.
Instead, it makes more sense to look at volume as part of the big picture when evaluating a particular stock. Traders usually use volume in combination with other factors like whether the price is declining or increasing, and how much volatility there is.
The trading volume of a stock reveals to investors how many shares are being transacted. Investors can combine this data with other information in their investigation. Volume doesn't always indicate whether reversals are about to occur, but it can offer traders some insight into what is likely to happen.
As presented above, investors will have an easier time selling a stock when the price is rising with high volumes. When a stock is not traded very often, and there is limited buying interest, an investor may have a difficult time unloading their shares. High volumes can indicate bullish or bearish sentiments and the level of investor conviction regarding a particular stock.