Trading volume: What it reveals about the market

Volume is the number of shares of stock, bonds, options, or futures con tracts traded over a designated period (e.g., daily, weekly, monthly). Advancing volume is the total volume for all stocks increasing in price; declining volume is the total for all stocks decreasing in price. To remove variability elements, it may be advisable to smooth this measure with a moving average (e.g., 5 days).

Volume reflects the intensity (strength) of a stock, commodity or index. Volume also provides an indication of the quality of a price trend and the liquidity of a security or commodity.

What volume reveals about the market's strength

High volume means greater reliance can be placed on the movement in price than if there was low volume, because heavy volume is the relative consensus of a large number of participants.
High volume indicates an active market; in an active market, the spread between bid and asked prices is usually narrower.
High volume is often characteristic of the initial stage in a new trend, such as a breakout in a trading range. Before a market bottom, investor nervousness leads to panic selling, a characteristic of which is high volume.
High volume is also attributable to a market top when strong buyer interest exists.
Low volume often exists during an unsettled period, such as at a market bottom. Low volume reflects a lack of confidence that is usually indicative of a consolidation period when prices are within a sideways trading range.
A sizable increase in volume may point to a breakout (start) or climax (culmination) of a move, which may be temporary or final. In a rare case, it may represent a shakeout.
Volume typically follows a trend, expanding on rallies and decreasing on reactions. Volume is useful in ascertaining how strong a change in expectations really is.
How volume and price moves reveal the market's trend

It is important to look at the relationship between volume and price. A price move, up or down, that is on higher volume is more significant. Therefore, an analysis of price and volume allows the investor to better interpret the trends in price and any changes thereto. In other words, volume gives an indication of the strength (momentum) of a move in price.

Current trading volume and average trading volume should be compared. Average trading volume typically decreases when a stock is in a downtrend, because investors view negatively a stock declining in price. An increasing price is typically coupled with increased volume, but the price can decrease without an increase in volume if investors lose interest in the issue. On the other hand, a declining stock price may be coupled with higher volume when, for example, negative news comes out about the company.

The significance of a change in volume is related to the associated price trend or pattern. For example, a good time to buy stock is when there are simultaneous price and volume increases.
Volume Price Interpretation
Increasing Rising Bullish

Decreasing Falling Bullish

Increasing Rising Bearish

Decreasing Falling Bearish


Volume should be evaluated in appraising market strength or weakness. If volume is increasing, whether prices are going up or down, it is probable that prices will continue their current trend. However, if volume is decreasing, the current trend will probably not continue and a reversal may be imminent.

A strong uptrend usually has more volume on the upward legs; similarly, a strong downtrend will have more volume on the downward legs. After the trend ends the corrective leg usually has lower volume. A downtrend may nevertheless be extended whether average trading volume increases, decreases, or is static.

Volume is relative in that it usually is greater approaching the top of a bull market than near the bottom of a bear market. Further, trading volume typically increases and continues higher than average in an uptrend, but is below average during a downtrend.

Trading volume typically goes up as the price breaks out to the upside of a pattern or formation. In this case, a significant increase in volume is a strong buy signal. However, volume is an indicator of a trend reversal if it goes in a direction contrary to a prevailing trend.

Volume / price analysis, on balance volume, upside/downside volume ratio and line, volume up days / volume down days, cumulative volume index, trade volume index, positive volume index, and volume reversal are among the ways volume can be analysed.

Summary

The following guidelines apply to the study of volume:

The market is bullish if a new high occurs with heavy volume. A new high on light volume is deemed temporary.
A new low price with high volume is a bearish indicator. A new low on light volume is less significant.
A rally to a new price high on expanding volume but with less activity than the previous rally is questionable. It may point to a coming reversal in trend.
A rally on contracting volume is questionable. It warns of a possible price reversal.
If prices advance after a long decline and then go to a level at or above the previous trough, the indicator is bullish when volume on the secondary trough is less than the first.
If the market has been increasing for a while, an anemic price increase coupled with high volume is a bearish sign. After a decline, substantial volume with minor price changes points to accumulation, typically a bullish indicator.
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