A volume is a measurement tool used across subjects. In math and science, it measures the amount of space inhabited by an object or a substance.
On the stock market, we measure volume in stocks, otherwise known as trading volume.
How many times does a stock change hands within a specified period of time? That is the problem we are solving. The solution equals the volume in stocks.
How Is Volume in Stocks Used by Investors?
Investors are glued to chart analysis and current events and always trying to predict a stock's next move. It’s almost like a game of chess, where every move counts — except your money is at stake when it comes to stock prices on Wall Street.
Volume is a technical indicator that is similar to a single chapter in a book. It zooms in on details for investors, but it doesn’t tell the whole story. Upward and downward trends could be forming right before their eyes; they just need to know what to look out for and comprehend the trends.
Higher volume equates to active trading. Demand is high for a particular stock, and traders are buying and selling it. The reverse is true for low volume, as the stock begins to sit and become stale. With some stocks, you see more volatility in terms of average daily volume than others. Depending on your trading strategy, high-risk purchases like these might be a wise investment decision.
Don’t let volume fool you — it can change on any given day based on stock splits or news announcements. This is why it should not be used as the sole indicator of a buy or sell position within a certain time frame.
Using Market Cap and Float With Volume in Stocks
To pull the story together, market cap and float can fill in the blanks between the chapters and chart patterns. You know the number of shares that are actively traded, thanks to the volume. But, how does that compare to the number of shares available to trade in a given period, whether that’s the short term or the long term?
Float in Stocks
Float is the hero, ready to assist. To calculate float, the formula is as follows:
Float = Total number of outstanding shares minus restricted stock and closely held shares.
When you have an actively traded stock, the volume can exceed float. This means that more shares were traded within the time measured than that of the overall number of shares made available.
Market Cap in Stocks
Market cap is also referred to as market capitalization. It is the overall value of a company’s shares of stocks. The formula is as follows:
Market Cap = The value of stock multiplied by the total number of outstanding shares.
A free-float market cap can be calculated by omitting locked-in shares, such as those that are restricted.
Investors use the market cap to gauge the size of a company. This also defines the company’s worth — what buyers are willing to pay during acquisition.
Market cap stocks are broken down into three divisions:
- Small-cap: These tend to be niche markets or emerging companies that are ambitious, carrying a market value up to $2 billion.
- Mid-cap: Trending between $2 billion and $10 billion in market value, mid-cap companies are competitive in the market, searching for continued methods of growth to maximize their potential and build on investors' wealth.
- Large-cap: The largest of them all, holding a marketing value of $10 billion or more. These companies hold the least risk and are strong options for long-term investors.
What Does the Volume in Stocks Tell Investors, and How Is It Calculated?
We know that the volume in stocks tells us how many shares are traded, but why is volume vital to investors? The keyword here is liquidity.
When stocks are bought and sold rapidly on the market, investors can swiftly enter or exit their position. That’s why volume is considered a crucial element, especially as prices consistently fluctuate.
What is the relationship of volume to price movement? Often, as volume increases, the price moves with it.
Volume is calculated in two formats. The first is the trading volume. The second is the dollar volume. Dollar volume is expressed by multiplying the trading volume by the price.
High Volume Versus Low Volume
As interest peaks in the market, volume is at its highest. Stock is bought and sold, moving from one day trader to the next.
The value of the stock can be in either position, an uptrend or a downtrend. However, as the volume increases, the price is soon to follow. High volume and upwards prices are strong indicators of a bullish market.
On the contrary, low volume tells investors that traders are shying away from it. They are moving on to something else that is growing popular in the market. Low volume and downward prices signify a bearish market.
Where Is Volume in Stocks Shown on a Chart?
Look to the bottom of the price charts. Do you see the representation of a bar graph? Volume in stocks is generally located there.
Colors such as green and red are used to educate investors on the trending activity. Green signifies the net buying volume, and red represents the net selling volume.
Types of Volume Indicators in Stocks
Let’s break down the different types of volume indicators investors look for.
On-Balance Indicator
Also known as on-balance volume (OBV), this indicator measures the buying and selling pressure of a stock. The result of the equation is not as important as the direction it flows in.
When the stock closes at a greater value than on a previous close, it is considered up-volume. It is down-volume when it closes at a lower value than the previous day.
Here are some observations to consider when using the on-balance indicator:
- Upward trends continue when the OBV and the price hold higher peaks and troughs
- Downward trends continue when the OBV and price hold valley, or lower peaks
- Warnings of upward breakouts occur when the OBV rises
- A falling OBV warns investors of a downward breakout
- If prices peak but OBV does not, negative divergence is underway
- Positive divergence is possible if prices decline and OBV does not
Volume RSI
RSI stands for Relative Strength Index. Volume RSI leverages upwards and downwards volume changes in its formula. On the other hand, the standard RSI formula focuses on price changes.
Consider a range of 0% to 100%. The volume RSI should fall at or around 50%. Look for:
- Readings above 50% - a bullish market is underway, and it may be a good time to purchase shares.
- Readings below 50% - a bearish market is dominating, telling investors to sell, sell, sell!
Volume Price Trend Indicator
“Which way do we go, George? Which way do we go?”
Use the volume price trend indicator (VPT) to guide you down this path. It provides investors with a sense of direction, but it also dictates the strength of a price change.
Investors can interpret the VPT as follows:
- There is upward movement when price and volume increase
- There is downward movement when price and volume decrease
- If prices increase while volume decreases, negative divergence may surface
- If prices drop while volume increases, positive divergence lurks nearby
Money Flow Index
Now it’s time to look at the relationship between time and volume with the money flow index (MFI). You may also know this indicator by another name: the volume-weighted relative strength index.
The money flow index is interpreted similarly to the Volume RSI. Trading signals arise based on bullish and bearish divergence, crossovers, and when shares are either overbought or oversold.
Chaikin Money Flow Indicator
Use the Chaikin Money Flow indicator with the MFI. The typical look-back period is 20 to 21 days. It directs accumulation distribution, which we will cover next.
Accumulation Distribution
When stocks are accumulated, an investor is purchasing them or buying more shares. At distribution, those shares are being sold or off-loaded from a portfolio.
How is money flowing in and out of a stock? Accumulation distribution (A/D) indicators can tell us.
Here are examples of how it works:
- Uptrends are predictable when price and A/D show high peaks
- Downtrends often occur when price and A/D have low peaks
- A rising A/D alludes to accumulation, warning investors of an upward breakout
- A declining A/D signifies distribution, warning investors of a downward breakout
The Bottom Line
Investors use the volume in stock as a key indicator of trends and patterns. It is used in technical analysis, showing the number of shares bought and sold within a specified period.
The volume in stock is often skimmed past, especially by newer investors. It should be used in conjunction with other forms of measurement to complete the story, benefitting the decisions traders make.
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Sources:
Volume Definition | Investopedia