Understanding what is trading volume: When investors decide to make investments in the stocks, they can follow these approaches: Fundamental Analysis, Technical Analysis, or a mix of both. Fundamental analysts tend to focus on financial numbers like revenues, profits, growth rates, free cash flow, etc.
They crunch a lot of numbers to arrive at the intrinsic value of the stock so that informed investment decisions can be made. While fundamental analysts have these financial numbers to follow, do you know what technical analysts look at while analyzing stocks?
They check the trading volume of the stocks. In this article, we will walk you through the concept of what is trading volume and how it affects stocks and investing decisions.
What is Trading Volume and its Example?
Trading volume is defined as the total number of shares that were traded during the given time period. It is a technical indicator as it gives an idea about the overall activity of a security or market.
In simple words, the trading volume includes every share which is being bought and sold during the time period under consideration. For example, 50 stocks of a particular company were purchased and then sold again on the same trading day.
Now, the trading volume for that stock should be 100 even though 50 stocks were traded in the market.
Market technicians tend to use trading volumes to confirm the existence or continuation of a trend, or sometimes for trend reversal. Trading volume can help investors in their decision to buy or sell a particular security. It can provide signals to make an entry.
It gives an idea of when an investor should book profits and sell particular security as a result of low activity. Investors use volume in conjunction with other indicators, rather than alone. This helps them to gain insights into trend direction and the timing of trades.
Also Read: Fundamental vs Technical Analysis of Stocks – Which one is Better?
How does Trading Volume Affect Stocks?
If a stock is having a high trading volume that continues to rise, investors can presume that there is buying pressure. This is because the demand of investors tends to push a particular stock to higher prices.
However, if the price of a stock having high trading volume continues to fall every single day, it should mean that more investors are selling shares.
Market technicians believe that the most common timeframe to use is daily volume. When considering volume at the time of evaluation of a particular stock, investors should always assess how difficult it can be to sell their shares.
Stocks having low volumes can be difficult to sell as there could be little interest from the buyers. Apart from this, low-volume stocks are volatile, which can prove to be risky for investors. Stocks having high volume can be much easier to sell at the desired price.
Mostly, the impact of trading volume is neutral. Since thinly traded stocks have wider spreads between bid and ask prices, their prices move in a knee-jerk manner. On the other hand, stocks having higher trading volumes have smoother movements.
However, the difference is visible when the company announces some important news. When important news becomes public, stocks having higher trading volumes will see a one-time jump or drop. Thereafter, the trading becomes relatively smoother.
This happens because there are a large number of investors tracking the stock and they can make rapid assessments of the impact of such news.
Comparatively, stocks with lower trading volume can see much greater swings. The price movement can even last for days as the lower number of investors fight to agree on the relevant price for the shares. Trading volume has a significant impact on the movement of shares.
Therefore, investors who try to invest in stocks having lower volumes should be aware that the stock can see huge volatility. Therefore, they need to invest according to their risk appetite.
How volume helps in trading
When the stock rises, it depicts strength. Therefore, the trading volume helps in making an assessment of how convinced traders are about the stock, or market. Higher volumes give an indication of strong conviction with the direction in which a particular stock is moving.
Trading volume helps in determining whether the market is exhausted with the stock or not. Whenever there is a significant change in stock price along with a sharp rise in volume, investors can conclude that the trend is ending.
In Closing
While trading volume is mostly used by technical analysts as a technical indicator, some fundamental analysts use trading volume to get an idea about its volatility. How will investors perceive a piece of information? How will the stock price react?
All these questions can be answered with the help of trading volume. Traders use trading volume in combination with other indicators. This helps them determine market trends and in making smart assumptions about the direction of stock price.
That’s pretty much it about What is Trading Volume. Hope you enjoyed reading our article. Happy Investing!
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