Turn up the volume on stocks

Here's what the market's volume says about stocks now.

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Keys to volume

  • Volume can be used to confirm the direction of a trend.
  • Investors can assess volume relative to recent data, similar periods in the past, an average, or a benchmark.
  • The S&P 500's trading volume might suggest the momentum behind stocks may need additional strength.

More than halfway through the month, stocks are on pace for their best October since 2015. That follows the worst September since 2013. Stocks are trading within 1% of record highs, thanks in large part to blockbuster earnings for big US banks lately. But persistent COVID worries, a potential global energy crisis, the US and some other central banks initiating plans to taper back their assistance, and China’s real estate troubles have some investors worrying that the bull market may not have the strength to continue.

From a charting perspective, the long-term uptrend is evident looking at a multimonth chart of stocks. Tactical investors that are trying to determine short-term market direction might look to see what volume is saying about US stocks.

Volume is vital

Volume (or the lack thereof) can be a helpful piece of information in the trading process. For example, analyzing trends in volume can help you validate patterns if you are an active investor that incorporates charts and trends into your strategy.

Volume is simply the number of shares traded in a particular stock, index, or other investment over a specific period of time. For example, as of October 17, 2021, the most actively traded US stock, based on a 90-day average, was Camber Energy (CEI) with an average of 135 million shares traded per day.*

From a chart analysis perspective, volume is critical. Indeed, 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 investing time frame), an average, or some other benchmark. You should also consider seasonal differences in absolute volume amounts as well as 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.

Several things stand out in the chart above. First, the long-term trend appears to remain bullish. Since the COVID-19 nadir in March 2020, US stocks have nearly doubled. The pace of the rally has slowed since September, but October's rally has put the S&P 500 back within striking distance of the all-time record high.

However, volume does not appear to be increasing along with the trend in the price. There does look to have been a slight increase in volume recently compared with the previous months, but that may be due to the seasonal trend for volume to decrease over the summer, and then pick up during the fall. Basically, you don't see volume rising to new highs along with the price rally to record highs. Given that volume may not be confirming the bullish trend in stocks, investors may want to exercise some caution.

Volume patterns and indicators

For a wide range of 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. Looking at the chart above, a potential reverse head and shoulders pattern may have developed in recent weeks, which would be a bullish indicator for stocks. A left shoulder may have formed in early September, and the right shoulder may currently be forming, with a lower head forming in early October. 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

The key drivers of the stock market will remain earnings growth, how companies continue to navigate the COVID-19 pandemic, and other factors. However, it may be possible to tune out much of the other noise and look to volume, along with additional signals, for evidence of what stocks might be up to next.

Next steps to consider

Find new investing ideas and get up-to-the-minute market data.

Learn what you need to know before trading the market.

Learn about more technical indicators and how they can help you trade.

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