What volume says about stocks

Volume might not suggest stocks have bottomed.

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Keys to volume

  • Volume can be used to confirm the direction of a trend.
  • Investors can compare current volume to volume of preceding periods, similar periods in the past, an average, or a benchmark.
  • The Dow Jones Industrial Average's trading volume might suggest the October rally may be on shaky footing.

Stocks have rebounded sharply thus far in October. But they've been volatile (as is often the case in the runup to US midterm elections) and are still on pace for steep losses during 2022. The primary market drivers for the remainder of the year may continue to be inflation trends, central bank interest rate moves, Ukraine developments, and how those factors impact earnings.

From a charting perspective, the decline in stocks this year interrupted the long-term uptrend. Tactical investors that are trying to determine short-term market direction might look to see what volume is saying about US stocks. Based on volume for the Dow Jones Industrial Average, there's reason to be cautious about the October rally that has some investors thinking stocks may have hit a bottom as we enter the final months of 2022.

Volume is vital

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 27, 2022, the most actively traded US stock, based on a 90-day average, was Advanced Micro Devices () with an average of 95 million shares traded per day.*

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. 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 Dow Jones Industrial Average. The top half of the chart shows the daily price of the Dow and the bottom half shows the corresponding daily volume.

Several things stand out in the chart above. Following a big rally in 2021, stocks have been in a downtrend for most of this year. However, the Dow is up roughly 11% thus far in October, cutting stocks' decline to 12% year to date. That's led some investors to wonder if stocks have finally found a bottom in 2022. 

From a chart perspective, volume may not be increasing commensurately with the uptrend in stocks. There has been an increase in volume recently compared with 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. Compared with the same time last year, the Dow's volume is roughly the same. Basically, even though the Dow has been rising over the short term, you don't see volume increasing compared to last year. Given that volume may not be confirming the bullish trend in stocks, investors may want to exercise some caution 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 continue their October rise or if they falter, there's no shortage of things you may want to keep your eye on. Those include the Fed's next potential rate hike, inflation trends, developments in Ukraine, the housing market, and how everything impacts earnings.

In addition to these factors, if you are also using charts to assess the market, it may be possible to tune out much of the other noise and look to volume and additional technical 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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