Trading Stocks Daily
Trading Stocks Daily
Understanding Volume When You Trade Stock
Investors always focus on the price of a stock, but equally as important is volume. Trading volume will tell you the underlying psychology behind a stock’s price movement, and understanding that psychology will give you hints as to whether a stock’s movement is sustainable.
At the simplest level, volume signifies the amount of interest in a stock. If there is high volume in the amount of stock being traded, there is a lot of interest in the stock. Low volume means that there is not much interest in the stock.
Volume means nothing without price
However, volume does not exist in a vacuum. It’s only useful in relation to price. A move on high volume is significant. If a stock is maintaining an average volume of sales within a narrow price range and then suddenly shows an increase in price range and volume of stock trading, this indicates more interest in the stock. It will also probably go higher in price. In other words, the stock now has upside momentum. The converse is also true.
Going into more detail, a stock may be in a sustained uptrend or downtrend if you see the stock price move like a ladder – higher highs and higher lows going in stair-step fashion and if volume on down days is less than volume on up days. The psychology there suggests that people in the stock for a quick trade sell out as the stock moves higher while the more serious long-term investors hold on, and more jump in on the days the stock moves higher. The converse is also true.
Length of range-bound behavior is important
When a breakout eventually comes, it is most significant when the stock has been trading in its previous range for a long time. The best candidates for these “breakouts” are stocks that have been trading in a narrow range for 3 or 4 months. This is known as a consolidation. The psychology behind this behavior is that neither bulls nor bears have enough confidence in or against the company to drive the price significantly higher or lower. Usually it is some macroeconomic news, or some news specific to the company or the sector it’s in, that will break the stalemate.
But whether that stock’s breakout in either direction is sustainable or not will depend on volume. That’s why you want to look at the average daily volume over the previous 30 days before you trade stock. If you see volume exceed that average (especially if it significantly exceeds it) for 3 days in a row, then the breakout is more likely to be sustainable. However, if volume is much lower than the average, beware. This may be known as a “false breakout”, and you’ll likely see that stock return to its previous trading range.
Final rules about volume
High volume often suggests the initial or final stage of a trend. As discussed, that trend may be a breakout of a trading range. It is also useful for observing possible market tops and panic bottoms. When everyone is piling into a stock or index after a sustained upward move, this climactic buying may indicate that buyers have been exhausted. Likewise, at a market bottom, investor nervousness leads to panic selling, and that may indicate seller capitulation.
High volume means a greater reliance can be placed on price movement than if there was low volume. Heavy volume suggests some kind of consensus amongst a large number of participants. If there were, say, a big move up but on weak volume, it suggests that there isn’t much conviction behind that upward move.
Finally, high volume indicates an active market. If you are interested in a trade stock where the spread between bid and ask prices are wide, that increased volume will narrow that spread, allowing you to obtain or sell the stock closer to your desired price.
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