Keys to volume
- Volume can be used to confirm the direction of a trend.
- Investors can assess volume relative to recent data, an average, or a benchmark.
- The S&P 500's trading volume suggests investors may want to exercise caution during the recent upswing.
Volume is vital
Just as more clues help detectives solve crimes, volume (or the lack thereof) can be a helpful piece of information in the investment decision-making process. Analyzing volume can help you validate patterns and identify trends.
Volume is simply the number of shares traded in a particular stock, index, or other financial security. For example, as of June 11, 2018, the most actively traded US stock, based on a 90-day average, was General Electric (GE) with an average of 74 million shares traded per day.1
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. Similarly, 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.
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.
In late January and early February 2018, US stocks turned bearish. During this time, volume increased dramatically (see chart above), confirming the bearish move. The stock market has yet to recover to its high point before the selloff.
More recently, stocks have turned higher. However, volume remains at or below the same level that it has been at since mid-February. This might be considered non-confirmation of the recent bullish uptrend, suggesting active investors may want to remain cautious over the short term.
Of course, it should be noted that volume tends to be cyclical and may need to be analyzed relative to similar time frames. Seasonal patterns suggest that volume could continue to decline over the summer, relative to the rest of the year, as has been the recent historical trend.
Volume patterns and indicators
For a wide range of chart patterns, volume is essential. Here are 2 examples of common technical trading patterns used by slightly more advanced chart users, and how volume plays a role in the analysis:
- 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.
- 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 even 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
You may hear many a market prognosticator calling for the market to do this and that. However, it is possible to tune out much of the noise and look to volume, along with other technical and fundamental signals, for evidence of what stocks might be up to next.
Next steps to consider
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