The two most fundamental figures in the stock market are price and volume. The financial press reports trading volume for individual stocks and for the market as a whole. Many keywords you will come across in the financial news media, such as liquidity and shallow or deep trading, will start to make sense once you understand how volume is calculated, and why it matters.
In a public stock exchange such as the New York, London or Frankfurt, transactions are recorded and publicly displayed. At any point during the day, you can access a list of all transactions, including the various prices at which a stock changed hands, how many shares were traded every time, and exactly when the stock changed hands. Therefore, it is fairly easy to calculate the total number of shares that were traded over the course of the day. The total number of all shares that changed hands in a market such as the NYSE figure is known as the total market volume.
Trading volume is reported in terms of the number of shares that were traded and as the dollar amount of trading. An example will help illustrate this point. Assume Exxon Mobil changed hands only twice during the day. First, 1 million shares were bought at $12 a share; later, 2 million shares were purchased at $12.50 apiece. The total trading volume is 3 million shares. The dollar amount of trading equals $12 x 1 million + $12.50 x 2 million, totaling $37 million. In other words, investors handed a total of $37 million to one another while buying Exxon Mobil stock that day. The sum of dollar values of trades for all stocks in a particular market equals the dollar trading volume for that market.
The greater the trading volume in a particular stock or market, the more liquid that stock or the market as a whole is considered. A liquid market offers plenty of buyers and sellers and makes it easy to trade. In an illiquid market, on the other hand, buyers and sellers are hard to come by. In this market, you might have to wait a while before you could sell the stocks you owned or buy new shares. Established stock markets such as the NYSE have far greater trading volume and are more liquid than their newer, smaller counterparts in developing economies.
One consequence of high trading volume and the resulting liquidity is a narrow bid-ask spread. Bid is the price at which you can sell your shares, and ask is the price at which you can buy. The bid-ask might read $12.1 to $12.2 in a liquid stock, while it may be $10.5 to $11 in a less liquid stock. If you were to buy and then immediately sell the first stock, you would lose 10 cents per share, as you'd buy at $12.2 and sell for $12.1. But the same operation in the second stock would result in a loss of 50 cents. Therefore, liquidity results in a direct benefit for the investor.
Video of the Day
- Zedcor Wholly Owned/PhotoObjects.net/Getty Images