A stock's trade volume represents the total number of shares or contracts that are traded for a specific security during a specific time period. A stock's volume is high when its securities are more actively trading and, conversely, a stock's volume is low when its securities are less actively trading. When a stock begins irregularly trading at low volumes, it's usually a warning sign: proceed with caution. Low-volume stocks may express trading volatility, market uncertainty or a liquidity risk.
As volume decreases, any price fluctuations that occur may be less predictable than they were in times of higher volume.
Interpreting Price and Volume Action
Price action reflects investor sentiment. If a stock is rising, investors are eager to buy; if it is falling, investors are eager to sell. But for a move to be valid, the stock price action must be confirmed by volume. As technicians say, volume goes with the trend. Volume shows how much conviction investors have in a trend.
When you multiply the number of shares traded by the current stock price, you get the total dollar amount that investors are willing to put at risk. Low volume means few investors are putting only a little money at risk. You cannot trust such price moves, as they are fickle and can easily reverse.
Indecision or Uncertainty
When things are unclear, many investors tend to stay on the sidelines and stop trading, so the volume dries up. But if some traders feel compelled to act out of boredom or to entice others to act, their trades can push prices up or down in a slow market. Other traders may act prematurely, hoping to be ahead of the crowd. But if others do not follow those moves, stocks can quickly return to their previous levels.
It is easier to manipulate a stock when its volume is low. All a manipulator needs to do is execute a few carefully timed trades to create the illusion that a stock is moving so he can get others to buy or sell. The goal is to raise the price if he wants to sell and to lower the price if he wants to buy. If you are suckered in by such a move, your position can quickly turn into a loss as the stock you just bought suddenly reverses course on increased volume.
Thinly Traded Stocks
Some stocks simply routinely trade on low volume. The risk of trading a low-volume stock, besides the above reasons, is that behind each stock there is a professional trader who trades it day in and day out and who will try to profit from your order by moving the price away from you so you end up overpaying when you buy or getting less when you sell.