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Why Trading Volume Matters
Here’s a little trading riddle for you …
What kind of volume doesn’t make a sound but can have a big impact on your investments?
Trading volume is an extremely important and helpful technical indicator that can help you confirm trends and determine whether or not a stock is worth your time.
Here, we’ll discuss the basics of volume, including what it is, why it matters, and how you can use it to formulate a great trading plan.
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What is trading volume?
Trading volume is extremely easy to understand. It simply refers to the amount of stock shares that are being sold or bought during a specific period — for instance, during a trading day.
Why trading volume matters
Trading volume is considered an important indicator for traders, who can use this information as part of their research when considering stocks to trade.
Here are some of the reasons why trading volume matters:
- Identify momentum / trends. One of the biggest benefits of looking at trading volume is that it can help you determine whether a stock has good momentum (price movement). If you see an increase in volume, this can help you confirm trends that may work in your favor.
- See the price action. In looking at the trading volume, you can gain insight about the price action of the security in question. In general, the higher the volume, the higher the price will go for a stock. So, if a stock appears to be gaining in volume, this can be a sign that it’s poised to increase in price as well.
This works in the opposite direction, too: If the volume is decreasing, the price often follows suit.
- Determine ease of entry and exit. Many traders will look for the biggest gainers. However, this information doesn’t mean much if there’s no volume. The thing is, the volume of a stock will give you an indication of the ease of entry and exit in a trade.
With a high-volume stock, you can feel fairly safe in that you’ll be able to get out of your position without too much trouble. A low-volume stock, on the other hand, can provide more resistance in this regard.
- Cross-reference other research. Looking at trading volume can help you make sense of your other research as a trader.
For instance, you might start seeking out stocks by looking at the biggest gainers. But any one indicator won’t tell you the full story.
Using trading volume as a check and balance to gain a bigger-picture view of a stock can help you make the wisest choices with your investments.
How to use trading volume: an example
Here’s an example of how you can put trading volume to work …
Say that you as an investor have been monitoring Company X. In the past couple of weeks, the shares have gone up about 15% in price.
Upon seeing that the stock is a gainer, you may be interested in trading. However, it’s hard to know if this trend will continue on its upward trajectory, even if the company has been steadily growing for the past few years.
Here’s where trading volume comes in the picture. If in addition to being a gainer, there’s also good volume, then this can be a good sign that the stock will continue on its upward trend.
Is bigger always better?
If you’re following the “buy low, sell high” model, then yes, higher volume is more desirable. A stock with higher volume is far more likely to provide a stable investment.
A stock that is appreciating value but has low volume could be a sign that the trend won’t continue or that demand isn’t as high as the price might make it seem at the moment.
Another reason to be wary of low volume stocks is that they have a wider bid-ask spread. This refers to the difference between the bid price and the ask price, and is based on supply and demand.
However, this doesn’t mean that low-volume stocks should always be avoided. There are times when you’re simply ahead of the curve.
If you’ve found a company that you think may have an impact or might have big earning potential and get in on the ground floor, you could potentially profit from investing early. This doesn’t happen frequently, though.
How can I find trading volume?
Figuring out the trading volume is a cinch with StocksToTrade, where you can choose stocks based on your desired criteria such as sector, top gainers, etc., and then filter by volume to narrow down your choices.
Trading volume is a simple indicator that can have a big impact on helping you choose potential trades.
By taking the time to consider the trading volume of a stock as part of your research, you’ll be better able to narrow down your choices and choose the investments that are best suited to your trading style.