Imagine if you knew the amount of demand for a particular product or service. If it had a high demand, you might try to buy and then sell it to make a profit for yourself. In stock trading, volume refers to the number of shares that exchange hands from buyer to seller over a given period, sometimes in a span of just a few minutes.
Stock traders are always on the lookout for discrepancies in the stock market to make a profit. Besides price, traders also use volume as way to gauge where a stock is heading either up or down. A share price increase by itself doesn't necessarily mean the stock will continue to rise. However, a rising stock price coupled with high volume is a strong indication of a rise in share price. As more and more traders notice the increase in share price, more bids come in to buy the stock, which increases demand for the stock and creates a trading opportunity.
Low-volume stocks, or stocks that trade infrequently, are said to have less liquidity: The stock changes hands between buyers and sellers less often. As such, it is harder for a trader or investor to get into and out of the stock at the price she wants. Traders tend to avoid low-volume stocks because they present less trading opportunities.
If you visit a financial website like Yahoo Finance and enter a stock symbol, you'll notice in the financial metrics section, an item called "Average Daily Volume." This measures the average times the stock exchanges hands on a daily basis. Average daily volume is calculated over the period of one year. When a stock's volume rises above its average daily volume, traders take notice. A spike in volume is a sign of a trading opportunity. For example, if a company announced negative news, a decline in its stock price should coincide with trading volume above its average daily volume, as investors look to exit their position in the stock.
Technical analysis uses historical stock price charts and graphs to predict future price movements. Average daily volume is one of the many metrics traders use to determine market activity. Traders use technical analysis based on volume to confirm a trend. For example, if volume begins to decline in an uptrend, it is probably a sign of a trend reversal. In such a case, a trader who owns the shares may initiate a trade to sell ahead of his expectation of a decline in the stock price. In fact, trading volume is widely published and followed for individual stocks and exchanges, such as the S&P 500, for information about market sentiment.
- stocks and shares image by Andrew Brown from Fotolia.com