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What volume says about stocks

Key takeaways

  • Volume can be used to confirm the direction of a trend.
  • You can compare current volume to volume of preceding periods and similar periods in the past.
  • US stocks have fallen since the late-July peak, but volume has not confirmed this downtrend.

Despite a mostly positive start to this earnings season, stocks aren't making much noise amid a myriad of market and geopolitical factors. With a potential Fed rate hike forthcoming as we approach the so-called "best 6 months" of the calendar, it's reasonable to think that stocks could move in either direction.

If you are trying to figure out which direction stocks may go over the short term, volume is one of the most important tools that traders who use charts have. Based on the charts alone, the S&P 500's relatively low volume over the past several months suggests the recent downtrend may not continue.

Volume is vital

Volume is simply the number of shares traded in a particular stock or other investment over a specific period of time. For example, as of October 19, 2022, the most actively traded US stock, based on a 90-day average, was Tesla () with an average of 126 million shares traded per day.1

Analyzing trends in volume can help you validate patterns if you use charts and trends in your strategy. Technical analysts believe that volume precedes price; to confirm any trend, volume should increase in the direction of the trend.

For instance, if a stock were to increase from $23 to $25 on high volume relative to the recent trend in volume for that stock, technical analysts would consider this to be a more sustainable bullish trend (i.e., the stock could keep going up over the short term) than if the same price increase were to occur on relatively low volume. If a stock were to decrease from $25 to $23 on relatively high volume, technical analysts would consider this to be a more sustainable bearish trend (i.e., the stock could keep going down over the short term) than if the same price decrease were to occur on relatively low volume.

Price moves made on low volume may be said to "lack conviction" and could be viewed as being less predictive of future returns. You can tell when volume is high or low by comparing the current level to another time period (such as previous days, weeks, or months, depending on your time frame), an average, or some other benchmark. You should also consider seasonal differences in absolute volume amounts and volume trends.

What volume is saying now

Consider the chart below, which shows the average daily volume for the S&P 500. The top half of the chart shows the daily price of the S&P 500 and the bottom half shows the corresponding daily volume.

Stock volume hasn't strengthened with October's rally

This chart is described in the text above
Source: Active Trader Pro, as of October 18, 2023. Screenshot is for illustrative purposes only.

First, it's useful to identify dominant trends. From October 2022 to July 2023, the S&P 500 made higher highs and higher lows—a clear uptrend. Since July, stocks have made consecutive lower lows, suggesting a downtrend.

Meanwhile, volume has been relatively low during the downtrend compared with the same period last year as well as compared to moderately higher spring volume. Given that volume has not increased along with the existing downtrend (i.e., failed to confirm the downtrend), this suggests the bearish trend may not have momentum and stocks could move higher over the short term.

Volume patterns and indicators

It's worth noting that, for a wide range of other chart patterns, volume is essential. For instance, 2 technical trading patterns that incorporate volume include the head and shoulders and flag and pennant patterns:

  • In a head and shoulders pattern, volume usually decreases with each successive peak. If it does not, a trader might not expect the reversal pattern to complete. If volume does decrease with each peak and the pattern completes, the bearish breakout (i.e., a move lower) should then occur on increasing volume. The volume trends through the development of a traditional head and shoulders pattern differ from the reverse version, but a bullish breakout (i.e., a move higher) on a burst in volume after completion of the right shoulder in a reverse head and shoulders pattern would similarly confirm a trend reversal or breakout.
  • In flag and pennant patterns (short-term patterns completed in 1 or 2 weeks that are initiated by sharp and nearly straight-line moves), volume usually decreases during the pattern. If it does not, the pattern may not continue as expected. If the pattern completes, the breakout should then occur on increasing volume.

There are also some technical indicators that use volume, rather than price, as the central input. The Arms Index, for example, measures relative volume in advancing stocks versus declining stocks. A value below 1 for this index suggests bullish sentiment and a value above 1 indicates bearish sentiment.

On Balance Volume (OBV) is another indicator that incorporates volume. OBV tries to detect momentum by providing a running total of volume, showing when volume is flowing into or out of a stock or other security. OBV is used to confirm price trends and spot divergences. An upward-sloping OBV would be used to confirm an uptrend, while a downward-sloping OBV might confirm a downtrend. Both OBV and the ARMS Index are available in Active Trader Pro®.

Watch and listen

Whether stocks can scare up a rally through the final months of the year, after once again getting spooked in September, may depend largely on if investors think the Fed is finally done raising rates, among other factors.

But if you use charts to assess the market, it may be possible to tune out some of the noise and look to volume for evidence of what stocks might be up to next.

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Stock markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. Investing in stock involves risks, including the loss of principal.

Technical analysis focuses on market action — specifically, volume and price. Technical analysis is only one approach to analyzing stocks. When considering which stocks to buy or sell, you should use the approach that you're most comfortable with. As with all your investments, you must make your own determination as to whether an investment in any particular security or securities is right for you based on your investment objectives, risk tolerance, and financial situation. Past performance is no guarantee of future results. 1., as of October 19, 2023.

Past performance is no guarantee of future results.

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