How Does Volume Affect Stocks?

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Wouldn't it be helpful to know what company insiders and big institutional investors are doing before you buy or sell a stock? The good news is, you can. Big institutional investors that have research capabilities and the power to move a stock like no one else leave footprints when they move, and those footprints show up in the form of trading volume.

Stock Trading Volume Definition

  • Stock trading volume is the number of shares that are either bought or sold during a given time frame. Most stock charts display volume in bars or a histogram below the stock price area. Next to price, volume is one of the closest followed stock indicators. In fact, most technical analysis indicators are created by formulas that simply rely on various combinations of price and volume.

Liquidity

  • Liquidity is a measure of how simple or difficult it is to buy or sell shares of stock quickly. Volume, or the lack thereof, has an effect on liquidity. If the number of shares exchanging hands on a typical day is relatively low, the stock is considered illiquid. Conversely, if the number of shares traded is relatively high, the stock is considered liquid. The volume it takes to consider a stock liquid is debatable, but typically a company that trades more than 100,000 shares in a day can be considered fairly liquid.

Useful Stock Indicator

  • Volume can be a very useful tool for chart readers and stock traders who rely on technical analysis methods for making trade and investment decisions. Typically, big institutional investors are considered to have the most information about a company next to its insiders. When institutional investors move into or out of a position, they generally do so buying or selling large numbers of shares, which shows up on the volume charts. Chart readers use volume footprints in a few ways.

Volume Breakouts

  • A stock breakout occurs when the price breaks above an area of resistance, or a supply zone, that previously marked the point where it was repeatedly turned back. When a breakout occurs, it is important to pay close attention to trading volume. If volume on the day of the breakout is significantly higher than average trading volume for that stock, it is generally considered healthy. A breakout that occurs on high volume indicates heavy participation from institutional traders, and the price may be getting ready to start trending higher. Stocks that break out on low volume, on the other hand, should be looked at with suspicion because low-volume breakouts often fail and reverse lower on days that follow.

Volume Tops and Bottoms

  • Oftentimes stocks that have been trending higher or selling lower experience a high volume day at the top or the bottom of their trends. This is something to pay attention to because it could mean institutional traders are making a big move. When a particularly high-volume day occurs after a stock has been in an uptrend, it may mean that institutions are taking profit. Likewise, when a high-volume day occurs after an extended downtrend, it may mean that institutions are buying in. Both instances have the potential to project a future price reversal shortly after they occur.

References

  • Photo Credit Kick Images/Photodisc/Getty Images
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