Volume

Introduction

It’s interesting to note the various ways in which one can discern what’s going on within the stock market or even predict what’s in store.

You have the charts themselves, like those candlesticks and bars, and then you have the indicators, like EMA, SMA, or MACD.

However, there’s one thing that you may not often come across, and that is the volume itself and the various ways in which it can relate to the stock market, which is precisely what we’ll be looking at here.

What is Volume in Trading?

So what is trading volume within the stock market? Simply put, it’s a measure of the number of times any given financial asset is traded over a certain time period. For stocks, volume can be measured in how many shares are traded.

or options and futures, volume is dependent on the number of contracts that have shifted hands. Day traders and investors often look into volume to find liquidity and blend changes in volume and other technical indicators together to make their trading decisions.

The Purpose of Volume

Examining volume patterns over certain periods may help one ascertain a sense of what’s going on behind those declines and advances in entire markets and stocks. The same can be said for options trading, as volume may be a key indicator of current interest.

Furthermore, volume plays a vital role within technical analytics and is prominently featured in some major technical indicators. So, depending on how it’s used, it can confirm trends, identify market reversals, and validate breakouts.

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How to Interpret Volume in Trading

Now that you know what trading volume is essentially, you might want to see some of the different ways in which you can interpret that in your trading endeavors. So, let’s get into it then.

Volume Trends and Price Movements

If you have increasing volume within an uptrend, then that means that buyers are still interested in buying and are enthusiastic enough to keep the trend going.

However, the opposite is the case if you have decreasing volume within an uptrend, as that indicates that buyers are failing to keep momentum going and that the market might be due for a recovery.

But if a downtrend is accompanied by increasing volume, then it could imply that investors have increasing doubts regarding the stock, and this may cause more selling, leading to even lower prices.

But if you have decreasing volume within a downtrend, then investor concern may be limited. Although the price might continue to fall, those using volume analysis might begin to follow that stock and look for signs involving a pickup with rising volume.

Volume Spikes and Price Reversals

Sudden spikes in volume, also known as climatic volume, may also help people anticipate possible trend reversals.

For instance, if a downtrend displays signs of exhaustion and there’s this sudden increase in volume, all with prices continuing to stagnate or create bullish patterns like double bottoms, then it could mean a reversal in market sentiments is due, i.e., from bearish to bullish, or the support level being found.

Likewise, volume spikes amidst uptrends followed by price decreases could indicate a potential trend reversal towards the downside, with the resistance level being determined.

Volume Divergence

Volume divergence is basically when a stock’s price trends in one direction with the trading volume trending in the other.

So, bearish volume divergence happens when prices are increasing but volume is decreasing, which implies that traders don’t believe the current momentum to be sustainable.

On the other hand, bullish volume divergence would be the opposite, where prices are falling but trading volume is increasing.

How to Use Volume in Trading Strategies

You should have had a fair idea of volume interpretation now, so we’ll go more into how that can be channeled into trading.

Trend Confirmation with Volume

By now, you should be able to use the volume data to confirm uptrends or downtrends. If volume is increasing or staying consistent during uptrends, then that means that the trend still has life in it, and the same is true for a downtrend in that if volumes are increasing, then it could be an indication of more selling pressure.

Breakouts and Volume

Then you can also confirm the strength of a breakout using volume. So, if there is relatively high volume during the breakout, then it could indicate that the price might continue heading in that breakout direction.

In contrast, breakouts with low volume indicate the exact opposite, in that they’re more likely to fail, with prices not trending in those breakout directions.

Volume and Reversals

Using what we went over earlier, you can confirm trend reversals with volume and act accordingly, like buying during a bullish reversal and selling during a bearish reversal.

Volume Indicators

If volume analysis is something you’re more into, then there are a couple of well-known volume indicators that you can use.

On-Balance Volume (OBV)

On-balance volume, short for OBV, is a momentum indicator that incorporates volume flow to determine future changes in stock prices.

Volume-Weighted Average Price (VWAP)

The volume-weighted average price, or VWAP for short, happens to be a technical analytical indicator used within intraday charts that can reset at the beginning of each new trading session.

It’s basically the average price that a security has been exchanged across the day, based on price and volume.

Chaikin Money Flow (CMF)

The Chaikin Money Flow, also called the CMF indicator, is a method of measuring the distribution, i.e., selling pressure, and accumulation, i.e., buying pressure, of stocks over time.

Volume Strategies for Different Trading Styles

Let’s turn our attention towards how volume analysis can relate to some of the more popular trading styles within the landscape, particularly day, swing, and long-term trading.

Day Trading with Volume

In day trading, which focuses more on short-term gains or short trading intervals, traders may benefit more from those sudden volume spikes and short-term breakouts.

Swing Trading with Volume

For swing traders, whose priorities lie within medium-to-long-term gains, they may rely more on volume divergence strategies as well as volume and trend reversals, largely due to how they have more time to work themselves with.

Long-Term Investing with Volume

Those who are in the long haul with their trading goals may find accumulation and distribution indicators like the CMF indicator quite welcoming, while also utilizing any major or long-lasting trends they identify with their volume analysis to their benefit.

Advantages and Limitations of Volume

Like with any trading tool, there are benefits and there are limitations that come with volume analysis, and knowing those will go a long way in bettering your skills as a trader.

Benefits of Using Volume

Starting with the benefits, volume analysis in stock trading can help with confirming price movements and market sentiments, and because of that, traders can make more informed decisions.

Not only that, but it can work across various time frames. In other words, it can be tailored to fit your trading style, which is always a good thing.

Limitations of Volume

Now, on to the drawbacks. Firstly, the potential for false signals is very much there, and this is especially the case with low-volume markets.

Also, if you were wondering whether it serves as a ‘direct’ buy and sell signal like those other indicators, then you may want to look elsewhere, as that may not be the case here.

Conclusion

Volume can be a handy tool if you want to study trends. Furthermore, as we’ve already discussed, there are various ways of doing so.

Basic guidelines, like those we already discussed earlier, may be utilized to evaluate market weaknesses or strengths, as well as checking whether volume is verifying price moves or signaling the potential for a reversal to occur.

Indicators that are dependent on volume may sometimes be utilized to aid the decision-making process.

To summarize, although volume isn’t exactly a precise tool, exit and entry signals may sometimes be determined by simply looking at the volume, price action, or volume indicator.