Education Lesson 28
How to Use Volume to Improve Your Trading
Volume is a measure of how much of a given financial asset has traded in a period of time. For stocks, volume is measured in the number of shares traded and, for futures and options, it is based on how many contracts have changed hands. The numbers, and other indicators that use volume data, are often provided with online charts. Looking at volume patterns over time can help get a sense of the strength or conviction behind advances and declines in specific stocks and entire markets.
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.
Volume measures the number of shares traded in a stock or contracts traded in futures or options. Volume can be an indicator of 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.
On Balance Volume and Klinger Indicator are examples of charting tools that are based on volume.
A rising market should see rising volume. Buyers require increasing numbers and increasing enthusiasm in order 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 using the other volume guidelines.
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 the price on the move back lower doesn't fall below the previous low, and 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, 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 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.
source: By CORY MITCHELL Updated Feb 25, 2020
Here's a video by Tradingsim on How to Day Trade Using Volume