Turn up the volume

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 market may broadly remain indecisive, perhaps until the US elections resolve.

There are 2 primary things are dominating headlines these days: The upcoming US elections and COVID-19. The uncertainty in advance of the election and, possibly to a greater extent, spiking rates of coronavirus infections in the US and around the world may be a significant reason why stocks have been moving sideways for several weeks.

Tactical investors that are trying to determine 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, 2020, the most actively traded US stock, based on a 90-day average, was Apple (AAPL) with an average of 166 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.

What volume is saying now

You can tell when volume is high or low for an index, stock, or other investment by comparing it 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.

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, looking at the recent general trend of US stocks, the market has been little changed since early September (and may have formed a chart pattern known as a reverse head and shoulders—more on this later). Volume is down slightly from recent months, and it is down dramatically since the enormous COVID-19-induced volume spike during March and April. However, there is some conflicting volume evidence, as it is slightly higher than it was during the same period last year.

These conflicting signals, coupled with the sideways direction of the S&P 500, could suggest that market indecision might persist—perhaps until US election results resolve. Looking a little further out, investors might want to watch volume trends amid new information on infection rates and mortalities associated with COVID-19.

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, with a left shoulder forming in early-September, the right shoulder forming in mid-October, and a lower head forming in late-September. 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, and how companies navigate changes or developments in the election, 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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