Basics Of Volume Analysis

Table of Content

What Is Volume?

Trading volume is a measure of how much a given financial asset has traded in a period of time. For stocks, volume is measured in the number of shares traded. For futures and options, volume is based on how many contracts have changed hands. Traders look to volume to determine liquidity and combine changes in volume with technical indicators to make trading decisions.

Looking at volume patterns over time can help get a sense of the strength of conviction behind advances and declines in specific stocks and entire markets. The same is true for options traders, as trading volume is an indicator of an option’s current interest. In fact, volume plays an important role in technical analysis and features prominently among some key technical indicators.

Note: We also have a special guide on volume indicators.

Important Points To Remember:

  • Volume measures the number of shares traded in a stock or contracts traded in futures or options.

  • Volume can indicate market strength, as rising markets on increasing volume are typically viewed as strong and healthy.

  • When prices fall on increasing volume, the trend is gathering strength to the downside.

  • When prices reach new highs (or no lows) on decreasing volume, watch out—a reversal might be taking shape.

Basic Guidelines for Using Volume

When analyzing volume, there are usually guidelines used to determine the strength or weakness of a move. As traders, we are more inclined to join strong moves and take no part in moves that show weakness—or we may even watch for an entry in the opposite direction of a weak move.

These guidelines do not hold true in all situations, but they offer general guidance for trading decisions.

Trend Confirmation

A rising market should see rising volume. Buyers require increasing numbers and increasing enthusiasm to keep pushing prices higher. Increasing price and decreasing volume might suggest a lack of interest, and this is a warning of a potential reversal.

This can be hard to wrap your mind around, but the simple fact is that a price drop (or rise) on little volume is not a strong signal. A price drop (or rise) on large volume is a stronger signal that something in the stock has fundamentally changed.

Exhaustion Moves and Volume

In a rising or falling market, we can see exhaustion moves. These are generally sharp moves in price combined with a sharp increase in volume, which signals the potential end of a trend. Participants who waited and are afraid of missing more of the move pile in at market tops, exhausting the number of buyers.

At a market bottom, falling prices eventually force out large numbers of traders, resulting in volatility and increased volume. We will see a decrease in volume after the spike in these situations, but how volume continues to play out over the next days, weeks, and months can be analyzed by using the other volume guidelines.

Bullish Signs

Volume can be useful in identifying bullish signs. For example, imagine volume increases on a price decline and then the price moves higher, followed by a move back lower. If, on the move back lower, the price doesn’t fall below the previous low, and if the volume is diminished on the second decline, then this is usually interpreted as a bullish sign.

Volume and Price Reversals

After a long price move higher or lower, if the price begins to range with little price movement and heavy volume, then this might indicate that a reversal is underway, and prices will change direction.

Volume and Breakouts vs. False Breakouts

On the initial breakout from a range or other chart pattern, a rise in volume indicates strength in the move. Little change in volume or declining volume on a breakout indicates a lack of interest and a higher probability for a false breakout.

Volume History

Volume should be looked at relative to recent history. Comparing volume today to volume 3 years ago might provide irrelevant data. The more recent the data sets, the more relevant they are likely to be.

Volume is often viewed as an indicator of liquidity, as stocks or markets with the most volume are the most liquid and considered the best for short-term trading; there are many buyers and sellers ready to trade at various prices.


Volume FAQ

What Is the Most Common Time Frame for Measuring Volume in Stocks?

Daily volume is the most common time frame used when discussing stock volume. Average daily trading volume is the daily volume of shares traded, averaged over a number of days; this smooths out days when trading volume is unusually low or high.

What Trading Signals Can Be Provided by Volume?

Volume patterns provide an indication of the strength or conviction behind price advances or declines for a stock or sector or even the entire market. An advance on increasing volume is generally viewed as a bullish signal, while a decline on heavy volume can be interpreted as a bearish signal. New highs or lows on decreasing volume may signal an impending reversal in the prevailing price trend.

In the Case of a Pullback, How Can Volume Be Interpreted?

In the case of a pullback in a stock or market, the volume should be lower than it is when the price is moving in the direction of the trend, typically higher. Lower volume indicates that traders do not have much conviction in the pullback, and it may suggest that the market’s upward trend could continue, making the pullback a buying opportunity.