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The Importance of Volume in the Stock Market

Original post by Slav Fedorov of Demand Media

Volume is the total number of shares traded over a specific timeframe, typically a day or a week. Volume is measured and recorded for each stock and the market as a whole. Both are important in analyzing the sentiment and direction of the market and individual stocks.

What Volume Shows

Volume shows the dollar amount of transactions. For example: If a $20 stock traded 200,000 shares in a day, $4 million changed hands; if a $20 stock traded 200,000,000 shares in a day, $4 billion changed hands. The more money investors commit to a stock, the more serious they are about it. The same principle applies to the market as a whole: the higher the volume, the more investors are involved in the market, and the more active they are.

Company Size

The larger a company is, the more shares outstanding it has, and the larger its daily trading volume tends to be. For example: Microsoft has 8.378 billion shares outstanding, so it is normal for Microsoft stock to trade from 20 to 190 million shares a day, while a small software company with just 20 million shares outstanding may have a daily volume of only 200,000 shares.

Changes in Volume

To compare apples to apples, investors measure changes in daily volume rather than absolute levels. First, the average daily volume is calculated for the previous month or so; second, the stock’s daily volume is compared to its average daily volume.

Investor Sentiment and Stock Trends

Changes in volume help measure investor sentiment and validate a stock’s price trend. Volume generally goes with the trend: an uptrend is confirmed when a stock or the market rises on higher volume and declines on lower volume; a downtrend is confirmed when a stock or the market declines on higher volume and rises on lower volume. Extreme increases and decreases in daily volume indicate extremes in investor sentiment: excessive fear or greed. When a stock or the market rises on huge volume, it is an indication of extreme bullishness; when a stock or the market falls on huge volume, it is an indication of extreme bearishness. A more granular look may focus on such things as up and down volume (how many shares changed hands on the way up vs. down), or intraday volume changes as a stock price fluctuates.

                   

References

  • “How to Make Money in Stocks”; William O’Neil; 2009
  • “Technical Analysis of Stock Trends”; Robert D. Edwards, John Magee; 2010

About the Author

Based in San Diego, Slav Fedorov started writing for online publications in 2007, specializing in stock trading. He has worked in financial services for more than 20 years, serving as a banker, financial planner and stockbroker. Now working as a professional trader, Fedorov is also the founder of a stock-picking company.

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