:max_bytes(150000):strip_icc()/Primary-Image-how-to-buy-alternative-investments-7369694-0ebc4add57a84f85ab105e25d6a79bcf.jpg "Trading Volume: Analysis and Interpretation")
Trading volume is the total number of shares of a security traded during a given period. Trading volume is a technical indicator because it represents the overall activity of a security or a market. Investors often use trading volume to confirm the existence or continuation of a trend, or a trend reversal. Essentially, trading volume can legitimize a security’s price action, which can then help an investor in their decision to either buy or sell that security.
Key takeaways
Trading volume and momentum
Trading volume can help an investor identify momentum in a security and confirm a trend. If trading volume increases, prices generally move in the same direction. That is, if a security continues higher in an uptrend, the volume of the security should also increase and vice versa.
For example, suppose that company ABC’s stock has risen by 10% in the past month. An investor is interested in the company and wants to buy 1,000 shares. They conduct a fundamental analysis of the company and see that its earnings and revenue have consistently increased over the past year. However, the investor is not confident that the stock will continue in this upward trend and is concerned that the trend may reverse.
In this example, trading volume analysis can be very useful. The investor sees there has been a steady increase in ABC’s trading volume over the past month. They also note that trading volume was the highest ABC stock has experienced in the past two years, and that the stock is still trending higher. This indicates to the investor that ABC is gaining momentum and gives them confidence that the trend should continue higher. Thus, the increase in trading volume resulted in the investor buying 1,000 shares of ABC stock.
Trading volume and price definitions
Trading volume can also indicate when an investor should take profits and sell a security due to low activity. If there is no relationship between the trading volume and the price of a security, it indicates weakness in the current trend and a possible reversal.
For example, suppose the company ABC extended its uptrend by another five months and increased by 70% in six months. The investor sees that share prices of company ABC are still in an upward trend and continues to hold the shares. However, the trading volume is decreasing. This may indicate to the investor that the bullish uptrend in ABC stock is starting to lose momentum and may end soon.
The following week, the share price of ABC stock falls 10% in one trading session after being in an upward trend for six months. This results in the stock breaking its uptrend. More significantly, the trading volume is rising higher compared to its average daily trading volume (ADTV). The investor sells all the shares of ABC the next day because the combination of a sharp drop in price and increase in trading volume confirmed that the uptrend may be coming to an end and a reversal may be in the offing.
Use volume for more trading insight
Use volume for more trading insight
High or increasing volume in an uptrend can indicate a buying opportunity. Declining volume in an uptrend may indicate that it is time to sell and take profits. High or increasing volume in a downtrend may indicate that it is best to stay on the sidelines. Declining volume in a downtrend may indicate an upcoming reversal and a time to buy. More involved chart patterns, including the head and shoulders and the flag and pennant, use volume to confirm trends, reversals and breakouts.
What is a good trading volume?
Good trading volume for a security is difficult to define because trading volume’s value comes into play when viewed in context with other indicators, such as price direction and volatility. Any level of volume that gives investors specific insight into a security’s price action (and a sense of the trading interest in that security) can be considered good trading volume.
What does high trading volume mean?
High trading volume (relative to previous measures of that volume) accompanied by rising prices or an uptrend can indicate strong interest in a security by buyers. On the other hand, high trading volume accompanied by falling prices or a downward trend may indicate concern on the part of investors. This can lead to more sales and even lower prices. High trading volume may also reflect some isolated news or event related to the company associated with the stock.
Is low volume bullish or bearish?
Trading volume is defined as the number of shares traded in a given period of time. So, low trading volume may indicate a lack of interest in buying or selling. This means it can be bullish if low volume occurs in a downtrend. It can be bearish if spotted in an uptrend.
The Bottom Line
Trading volume is one of the metrics traders look at to predict the momentum of a stock or other security. An increasing trading volume can be a sign of favorable sentiment, indicating a likely price increase. A declining trading volume may indicate that the market is losing interest. As with other technical indicators, it is important to look at a wide range of metrics before making an investment decision.
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