Not many traders understand relative volume or how to use it in a trading strategy…
Relative volume is a kind of lesser-known concept that not many traders consider. Good for you for taking the time to expand your trading knowledge!
So what is relative volume? I’ll explain it here, along with why it’s important. And yeah, we’ll get into some gritty details.
That’s because there’s an easy way and a hard way to calculate relative volume. Strap in while I break it down! (And stay tuned for my top tip on any market approach.)
Table of Contents
- 1 What Is Relative Volume?
- 2 Why Is Relative Volume Important?
- 3 How to Calculate Relative Volume the Easy Way
- 4 Why Do Traders Use Relative Volume?
- 5 Relative Volume — The Hard Way
- 6 Conclusion
- 7 One Platform. One System. Every Tool
What Is Relative Volume?
Here’s the simple relative volume definition: relative volume is volume compared to average volume.
When it comes to relative volume — or RVol — there are two schools of thought. One is much more complicated, so we’ll start with the basics.
Averages are built from several factors using a period of time — usually five days, 30 days, or 60 days. In theory, you could use whatever period you like.
We’ll use the 60-day average volume here. StocksToTrade’s total view has a basics box with average volume that defaults to the 60-day period. See it for yourself — try StocksToTrade for 14 days for just $7.
Why Is Relative Volume Important?
Every move in the market happens because of supply and demand. Volume is the number of shares traded. Without volume, price doesn’t move much.
Relative volume tells us how many shares have traded in relation to how many shares are usually traded. It can be a great indicator that unusual price action may be on the way.
When you get unusual volume, you get unusual moves. Breakout traders and momentum traders look for big volume moves to inspire a trade. As a day trader, you want to be where the party is.
How to Calculate Relative Volume the Easy Way
The most basic way to calculate relative volume is to divide the day’s volume by the average volume.
What you wind up with is a ratio. Many relative volume scanners express this ratio as a single number.
Relative Volume Example
On January 14, Plug Power Inc. (NASDAQ: PLUG) traded 89.19 million shares. Its 60-day average volume is — and remember this is a number that changes — 37.6 million.
So, we take 89.19 million and divide by 37.6 million, and we get 2.372 and change. We can round it off even further. What is the stock’s relative volume? 2.37.
Why Do Traders Use Relative Volume?
In order for a stock to be in play, it needs to be liquid. The more liquidity, the better. That gets more eyes on the stock and more players in the game.
When a stock has what I like to call ridiculous volume, that’s when you get monster moves and parabolic runs.
Some traders use relative volume to decide which stocks they’re going to watch.
It can be helpful. Let’s say you set your scanners to find stocks that are trading one million shares in a day. At the end of the day you run your scan and come up with 1,000 stocks. That won’t help you find a trade.
Many of those stocks might have average volume of more than a million shares. So if volume is your only criteria, you’ll wind up finding a lot of stocks that aren’t trading exceptional volume.
With average volume, you get average moves. So a lot of traders like to use a relative volume indicator to help find potential trades.
What’s a Good Relative Volume Ratio?
During premarket, I’m looking for stocks that have traded at least their average volume. By the time the market opens, I’ve narrowed it down to stocks that have a relative volume ratio of at least four.
That means I’m looking for stocks that have traded at least four times their average volume. If they’ve rotated their float already, all the better.
Every morning in my Pre-Market Prep sessions (sign up for my daily premarket digest here) I go over the stocks that I’m watching. I talk about things like float rotation, excessive volume, and building a trading plan. Come check it out!
What Is a Low Relative Volume Ratio?
Anything less than 1 — for momentum day trading — just isn’t worth my time.
If a stock’s average volume is 100,000 shares, I want it to trade at least 100,000 shares in premarket. A relative volume ratio of 1 is still on the low side. I’m looking for at least 3 or 4.
How to Use Relative Volume in Your Trading Strategy
A key part of any trading strategy is finding the right stocks to trade.
While basic relative volume won’t be of much use in taking a trade, it’ll help you find stocks that are in play. Then you can build a strategy around what you find.
I go over this type of stuff every day in the SteadyTrade team. I go live twice, sometimes three times a day. Plus, we archive every webinar so you have plenty to study. Join the SteadyTrade Team to find your market footing. It’s an awesome way to grow as a trader alongside a killer trading community.
A Momentum Trading Strategy Using Relative Volume
Here are some key ingredients for a short squeeze. Now, the presence of all these things doesn’t guarantee a short squeeze. Nothing is guaranteed in trading. But if you can get all these things together, you increase your odds of success in a long-biased trade.
You’re looking for a stock that…
- Has a high relative volume ratio…
- Is a low float stock…
- Has a history as a former runner..
- Is in a hot sector…
- And has high short interest…
Building a Relative Volume Scanner Using StocksToTrade
StocksToTrade doesn’t have an RVol scanner built in, but it does have an easy way to build your own custom scans. It’s simple to add relative volume to any scan you build.
Open any scan you’ve built or start a new one. Add the volume block. Inside the volume block, set your parameter to criteria. In the drop-down menu, go to liquidity, then average volume, and select the period you prefer.
From there, you can set your scanner to find stocks that have a high volume ratio. Remember to use the % option and keep in mind that every 100% will equal one.
Here’s an example of a relative volume block that will scan for a relative volume of 10 or more, using the 60-day average volume.
Embed image: Relative Volume Scanner Code Block, courtesy of StocksToTrade
Relative Volume — The Hard Way
I won’t go too in-depth here, because this is advanced-class stuff. But there is a school of thought that you should know about. It’s based on the intraday volume distribution curve.
Intraday Volume Distribution Curve
For the most part, stocks tend to follow a volume curve throughout the day. Different time periods see different kinds of action.
The morning is the busiest period, in the first hour of the day. Then there’s a midday lull, followed by an afternoon push.
How to Calculate Relative Volume the Hard Way
Some traders use the intraday volume curve in their relative volume calculations.
You take the volume from a time of day and compare it to the presumed volume based on the average. I know, that’s a lot. Let me break it down.
Let’s say on average any stock trades 35% of its volume by 10:30 a.m. In this example, the stock’s 60-day average volume is 100,000 shares. On any given day, at 10:30 a.m., that stock should have traded around 35,000 shares (100,000 x 0.35 = 35,000).
Let’s say this company knows how to play the game. You see it’s put out a press release at 8:30 a.m., and the stock has some attention. By 10:30 a.m., the stock has traded 350,000 shares.
The relative volume in this example would be 10 at 10:30 a.m. That’s 350,000 at 10:30 a.m. divided by the presumed average volume at 10:30 a.m.
As you can see, you don’t have to be a math genius or a programmer to benefit from relative volume. In fact, you can often tell at a glance how liquid a stock is. With a few brief calculations, you can decide which stock may have the most eyes on it.
If you like the more calculation-intensive approach, it’s there for you. But if you ask me, it’s better to keep it simple. That’s my top tip for every trader.
Look for ridiculous volume and wait for those breakout patterns.
Tell me about your scanners! What about your favorite search criteria before you discovered relative volume? Leave a comment below!