How to Use Stock Volume to Improve Your Trading Setup

In the stock market or exchange, have you ever come across the wise saying of, “Actions speak louder than words” ? 

As it turns out, this wisdom is rooted in reality. In fact, some studies have indicated that about 70% of price movements in stocks can be explained by volume rather than fundamentals. 

Understanding stock volume, which refers to how many shares are sold or bought during a certain period of time, can provide unparalleled perspective toward market activities and scenario. This blog will go into deeper understandings of what it is and how can volume analysis help you polish your trading skills. Let’s tackle it, starting with.

What Is Volume Trading?

Picture yourself at an auction for a trending piece of art. The place is overflowing with people, and every time there is a new bid or two, more people push the price upwards.

In this scenario, we can say there is ”high volume” where there is sufficient backing for the high price. However, if you consider the inverse where the room is almost empty and there are only a handful of people who lodge a bid or two at random, then the situation feels quite bleak. This scenario shows that the support is minimal and so is the price increase.

Volume trading works this way.

In volume trading or stock volume, the focus is transferred towards the amount of shares of a stock being sold or bought. 

If the amount of shares being sold suddenly increases and the price moves upwards as well, this indicates more people are willing to purchase, pushing the price higher than the current. 

On the other hand, if the amount of shares being sold spike but the price drops, this means people see the price of said asset falling and are trying to sell their shares.

What is Volume?

It is defined as the total volumes of contracts or shares that are completed during a specified period whether this is a day or a minute. Think of a new video game that sells thousands of copies within its first hour after being released, this instant demand illustrates high volume. If however only a handful of people buy the game for 12 dollars during a day as opposed to hundreds considering the game, then that would be classified as low volume. 

Did You Know: The use of stock volume in trades began in the 1900’s when traders acknowledged the correlation of shares traded to the trends of the market.

Why Does Stock Volume Matter?

Through the use of stock volumes, traders are able to assess the level of interest a particular stock has or even the overall sentiment for that stock. High trade volumes can show the amount of interest a stock has as well the direction the motion/price of the stock is headed towards. 

As an example:

• With rising stock prices, a high stock volume might represent a significant amount of excitement over the stock, which could result in a price increase.
• And with a high volume and a lower price, it would most likely mean that people are attempting to sell the stock in large quantities, which would be bad for the stock.
• The “weak” moves tend to fail or come far from the high velocities as fewer people in the mix support them.

It is worth noting that about sixty percent of other traders rely on volume patterns to help them identify trends’.

Step-By-Step Guide to Trade Volume: The Basic 

In practicing volume analysis, it is critical to understand the fundamentals underlying price movement. In most cases, stock volume signals can be used to determine whether a particular price movement warrants further consideration or a second glance. 

Generally, we tend to stay market away from weak moves while trying to maximize our participation in strong turns. Sometimes we even decide to move against a feeble action as well.

But remember – these rules are never absolute and do not function all the time, however, they are quite useful in facilitating broad decisions regarding trading. Below are the appropriate steps in using Volume as one of the trading tools. 

Step 1: Observe Uncommon Volume

Volume provides an indication of how many people are selling or buying a given share. In the event of increased volume – Volume that is unusually larger than average – it indicates that there is an event of significance that is taking place in regards to a certain stock. 

For example: When a stock sells 50,000 shares on the average and you then see that it has spiked to 300,000, this indicates a growing interest in that stock, which could be for better or worse , or and drastic shift might be taking place.

Step 2: Using Volume to Validate a Trend

The movement of volume assists in determining whether a price trend is robust or weak. For instance, the strength of an increasing price would depend on having a significant volume alongside it, while a low volume would indicate a crack in the trend’s strength.

Example: Consider the stock price of a stock that increases steadily day by day. Assuming the number of people buying these stocks grows each day, it can be established that the volume will be high, indicating that these people trust that the prices are going to increase so the price rise is very likely.

Step 3: Identifying the Symmetric Movement of Volume and Price

Ideally, as the price increases, so should the volume. However, if the volume does not increase at the same rate as the price trend, there could be a possibility that the trend in which the price is currently situated could soon come to an end. 

Example: The price of the stock may be increasing however, the volume of people able to purchase the stock may be decreasing indicating that the stock is losing interest from consumers which could contribute the the price falling.

Step 4: Expect Divergences (Volume and Price Dynamics)

Divergence goes hand in hand with volume volatility. It is a situation where the price moves in a determined direction but the volume contradicts. This is an indicator that the trend will soon change.

Example: Following the same principle as above, if the price of the stock continues to increase but the volume starts declining, it is certainly a red flag. It likely suggests that there is a declining belief that the price will continue to increase, therefore realistically the price may well start to decrease.

Step 5: Observe Volume Around Critical Points (Resistance and Support Mechanism)

Support is defined as the lowest price at which a stock generally stops going lower. Resistance can be defined similarly except that it states the greatest price at which the stock will stop increasing. These parameters can be referred to as price zones. If there is substantial volume near these levels, chances are good that they will only be penetrated, not reversed.

Example: Assuming that a stock has a good history at Rs.800 that it may start but won’t stop below, this can still be called a psychological barrier frequently. Consider the Rs. 800 such stock, any rupee charge beneath the Rs. 800 on Rs.800 times, the volume shoots up and the coin may break it down at last.

Step 6: Identify Ranges 

Consolidation refers to a period where both price and stock volume hold constant. It indicates that the stock is currently “sleeping” before some impending action. 

Example: A share which is around Rs. 400 for a couple of days with low volumes could be looked at as pausing in a still zone for some action. Upon some increase in the volume, the range could get broken and tend to move upwards or downwards. 

Step 7: And Also Leverage Volume Metrics To Simplify 

Volume-based indicators like On-Balance Volume (OBV) make it easier to examine volume patterns over a set period. It can help you identify points of increasing or decreasing purchasing power. 

Example: OBV, on the other hand, combines stock volume on those days the price increases and takes into account the days the price decreases to give a graph that makes it easy to see if the trend over time is for buying or selling.

Step 8: Volume v/s Entry and Exit Placement 

Incorporate stock volume as an aid in determining when to enter or rest a trade position. When there is a considerable trend volume that is noticed, this would be a good indicator to enter. Low volume in close proximity to a peak or low price could act as an exit indicator. 

Example: An increase in stock volume when the price of a stock is on a bullish trend would imply that it is good to buy. If during the greatest price point volume is found to be decreasing, it could mean a good time to sell.

Crazy Fact: A high stock volume means that a stock has better liquidity. Which in turn implies that investors will be able to easily transact shares. The opposite is true for a low volume stock as it is less liquid making the price to have wider swings making trading it more risky.

Conclusion 

When we grasp how to distinguish whether the price move has a strong sentiment from traders, we know when to join the market, when to avoid the market, and even when to do the opposite. Volume helps to determine if there is any serious interest in a trend and if it will continue or come to a halt. 

For an advance in your trading, combine volume with the grasp of Demand-Supply Dynamics – an extensive technical analysis approach. It is often the case when such volume is observed in these demand-supply areas, it assists to forecast the future behavior of the price.

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