Volume is one of the basic parameters of the stock market that characterizes the amount of shares or contracts for a particular security sold in a certain period. In the stock market, volume is expressed in terms of the number of shares that have been traded within a particular period. In contrast, in the futures as well as options market, it is expressed as the number of contracts that have been traded within the same period. The volume also plays a crucial role in analysis; it helps traders understand the liquidity of a particular security and the general turnover of the market.
Through the analysis of volume trends, traders can develop better insights into the market which helps in their trading activities. This article includes a deep dive into what volume means for the stock market game.
Understanding Volume in the Stock Market
Each trade in the stock market contributes towards the daily turnover of a particular security. Every contract between a buyer and a seller in which they decide to swap shares contributes to the total volume. For instance, if there are five trades within a single trading session, every involving 100 shares, then the volume of trading within that trading session would be 500 shares.
Volume data is collected by exchanges and is typically reported on an hourly basis throughout the trading day. These hourly rates are approximate, and the trading volume for the entire day is also determined and stated on the subsequent day. This information is available either for free or through certain subscription services for investors and traders. Higher trade volume is most often connected with a more active and liquid market, thus better order execution and tighter spreads.
How Volume Reflects Market Activity?
Volume is an important variable that measures the level of trading activity and market depth. Higher volume is indicative of a more vibrant market, which means there are many buyers and sellers in the market. This can help to improve the overall efficiency of the price discovery process and the execution of trades. On the other hand, low trading activity may represent low demand for the security, which can result in higher bid-ask spreads and more volatile prices.
Generally, volume increases near the opening and closing of the trading session, as well as at the start and end of the week. Also, it tends to be lower during lunch periods and before holidays due to reduced market activity.
Role of Volume in Technical Analysis
In technical analysis, volume is applied to confirm trends in prices. Elevation in price on a larger volume is considered bullish, while a drop in price on a larger volume implies bearishness. On the other hand, a price movement of low volume can be termed a weak price movement. Business analysts employ volume in combination with other metrics to determine when to enter or exit a particular trend or whether it is strong enough to reverse.
Here are the three key volume indicators often used by the stock market traders:
1. On-Balance-Volume (OBV):
On-balance volume, or OBV, is a volume indicator introduced by Joseph Granville in 1963. It captures the buying and selling pressure of security and is useful in understanding the sentiment of a market. The value is determined by adding the volume of the day to the previous OBV if the closing price was higher than the past day or subtracting the current day volume from the previous OBV if the closing price was lower. Additionally, it also clarifies the trend strength or potential reversal by measuring the correlation between the price direction and volume.
2. Chaikin Money Flow (CMF):
The Chaikin Money Flow (CMF) is an indicator created by Marc Chaikin in the 1980s that calculates the volume-weighted average of accumulation and distribution over a period, which is usually 21 trading days. The indicator refers to buying and selling pressure in a specific security and is calculated based on the money flow multiplier and volume. A stock’s value ranges from + 1 to – 1, with a positive value showing a propensity for purchase and a negative value showing a propensity for selling. The CMF is most effective for plotting a potential divergence between price and volume, which can act as a trend reversal point.
3. Klinger Oscillator:
The Klinger Oscillator was developed by Stephen Klinger in 1977, and its purpose is to paint long-term trends in money flows, including short-term scalping. The oscillator takes the volume and price profiles and plots them on a single line that allows the trader to look for changes in trends. The oscillating between the Klinger Oscillator and the price of the security can help the trader determine the strength of the trend and possible reversal patterns.
How do Traders Use Volume in Their Strategies?
Volume is used by traders as one of the building blocks for developing their trading plans. Volume indicators help the trader to evaluate the strength of a market signal and thereby advantageously time entry and exit in the market. For example, if a trader sees a breakout at a higher volume, he has enough reason to go for the ‘buy’ signal. On the other hand, if price declines are realized on high volume, it may be interpreted as a signal to sell.
Traders usually consider the average daily trading volume of security in the short and long term to identify appropriate times to trade stocks. Furthermore, volume indicators such as the ones mentioned above may be employed by traders to enhance their trader strategies as well as the decision-making process.
The Impact of High-Frequency Trading on Volume
Currently, high-frequency trading (HFT) and algorithmic trading have emerged as key drivers of trading activity. These are trade automation systems that are programmed to carry out multiple trades in a short period and are commonly responsible for a significant percentage of total trading. It is estimated that the market size for algorithmic trading is currently over $2.3B and will rise to over $4B by 2030. Overall, the existence of HFT has enhanced the volume of trading in the market while raising a query as to the relevance of the volumes in trading since most of the trades are now facilitated by software programs.
Understanding the Relationship Between Volume and Price
In technical analysis, the volume-price relationship is significant. When both are bullish or bearish, it’s believed to be an indication of strong market sentiment. For instance, when the prices are going up while the volume also goes up, this may be an indication of more price increases, hence a strong uptrend, while if the prices are declining while the volume is also going up, then there could be a strong downtrend. On the other hand, increasing price with decreasing volume may indicate declining velocity or a downward trend.
Final Words
Volume is one of the key data points in stock markets that gives a lot of information on the activity, popularity, and sentiment of the market. From the volume patterns, it is easier for traders and investors to make the right decisions in terms of buying or selling securities. Be it a swing trader seeking to bank on price fluctuations or a positional trader aiming at gaining an insight into price trends, volume remains an instrumental part of any trader’s/investor’s toolbox.
Frequently Asked Questions
1. What does volume mean in stock?
Ans: Volume in the stock market measures the number of shares or contracts in a security that have been traded in a given time. Essentially, it is a measure of market turnover and can be considered an indication of market activity and volume.
2. Why is trading volume important?
Ans: Volume is crucial because it quantifies buyer and investor activity and gives clues to investors’ attitude toward a particular security. High trading volume means that there is a high turnover of shares in the market while low trading volume shows that the market contains low activity, or there is uncertainty in the market.
3. How is the trading volume in the stock market measured?
Ans: Trading volume is just the total number of shares or contracts exchanged for a particular security over a given period. It is measured and reported by relevant stock exchanges and financial intermediaries. Some brokers offer real-time volume data with candles in the lower part of the price chart, which shows the number of shares or contracts traded during specific time intervals.
