Introduction

Tens of thousands of stocks are traded daily on different stock exchanges and experience price shifts. However, price shifts don't always mean the same thing. For instance, stock prices can increase without any increase in the number of shares being traded or vice versa. Each situation shows the market activity, and you can use it to identify potential trends. A popular metric you can use is trading volume. You need to learn to use this metric to make smarter and better investment decisions.

In this article, you will learn stock trading volume, volume analysis in the stock market, and its interpretation.

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What is Stock Trading Volume?

Trading volume refers to the number of times you trade a specific financial instrument, such as stocks, commodities, bonds, etc, within a given time limit. It essentially denotes the number of times a financial instrument has changed hands. You can track this metric like you measure footfall at a retail outlet. Here is a simple example of how you can calculate trading volume. Let's assume you traded 3000 shares of ABC company at 10:00 AM, 5000 shares at 01:40 PM, and 1000 shares at 2:00 PM. So, the trading volume of ABC is 9,000 (3000 + 5000 + 1000) shares on the given day.

Trading volume includes both your buy and sell orders. If you actively trade a stock, its trading volume is high, and vice versa. The concerned stock exchanges publish trading volumes for each trading session. This includes the trading volume of individual stocks, and the combined volume of all stocks traded. You can easily find this metric on trading or brokerage platforms, stock exchanges, news platforms, or even a simple Google search.

Analysing Trading Volume

You can use trading volume to understand the sustainability and strength of prevailing market trends. Here is how you can do this.

Spot Trends

When the volume and price increase simultaneously, it signals significant market participation. You can use it to identify any potential price changes signalled by volume spikes.

Confirm Breakouts

If you notice a breakout while the volume is high, it suggests the price will continue to grow in the direction of the breakout due to increased market participation. However, if the breakout is on a low volume, it signals an absence of conviction.

Potential Reversals

If the price trend maintains but the volume reduces, the trend is losing momentum. You can use trade volume to identify any potential reversals.

Interpreting Trading Volume

Analysing trading volume is more about understanding the market conviction supporting a price movement than predicting the market. Market analysts interpret trading volume using a variety of indicators. Here are some indicators that you can use to identify potential trends, reversals, and breakouts.

Volume-Weighted Average Price (VWAP)

VWAP is the average price you pay per share weighted by volume during a specific trading day. It's commonly used to find the best execution price. For instance, if you trade lower than the stocks VWAP, it suggests selling pressure, while buying pressure is implied when it trades higher than its VWAP.

On-Balance Volume (OBV)

You can calculate OBV by adding and subtracting volume on up and down days, respectively. When the prices diverge from the volume pattern, you can use it to spot potential reversals. For instance, if the OBV reduces while the share price increases, it implies a reduction in buying pressure.

Chaikin Money Flow (CMF)

You can use CMF to confirm breakouts by combining volume and price data to measure the buying and selling pressures. Usually, you need a 20-day period for this metric. If the CMF is positive, it implies a buyer-dominated market and when its negative it implies a seller-dominated.

Accumulation/Distribution Line (A/D Line)

You can get A/D Line by multiplying a stock's volume by its closing price once it is in the trading range. When the A/D Line rises with increasing prices, it shows an uptrend, while a downtrend is signalled when there is any divergence. So, you can use it to determine whether to buy or sell.

Volume Rate of Change (VROC)

You can use VROC to measure the speed at which volume changes by comparing the prevailing volume with a previous one. It works like a speedometer and shows you how quickly the trading volume reduces or increases. Usually, there's a spike in VROC before significant price changes, and you can use it to identify breakouts.

Conclusion

Whether you are a trader or an investor, understanding trading volumes and interpreting them is a beneficial skill. It is an important metric, and you must consider it before entering, holding, or exiting a position. Don't forget to consider your trading objectives, investment goals, and risk tolerance before making an investment decision.

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