If you’re a technical trader, almost every study or indicator you use is based on price or volume data. Price always seems to get the attention because it directly affects portfolio values, but understanding how to interpret volume is a skill that can benefit traders in the long run.
Simply put, volume is the number of trades, or transactions, that take place in a stock. If the net price move during a specific time frame is higher, the volume during that time is considered “up” volume. If the net price move is lower, then it’s considered “down” volume.
Volume analysis is most informative when it’s considered in conjunction with a move in price. That’s especially true if the move is at a critical point like a support or resistance level, a moving average, or after an earnings announcement. Think of volume as the fuel behind a price move. The more fuel, so the thinking goes, the more likely the move will be sustained. The opposite is true as well. A move in price with little or no volume behind it is seen by some volume fans as more likely to fail.
Volume Spikes and Trends: Time Frame Is Key
The way you interpret volume has a lot to do with your trading time frame. If you’re a day trader watching a stock that you think is going to break out of an intraday pattern, then you might be looking for a spike in volume to accompany a price move. It might be an acute event, and once it’s over and the breakout is complete, price may continue moving higher even without a continued increase in volume.
For longer-term traders or investors, spikes in volume might not be as important to an overall trading plan. Instead, investors might want to see a sustained, consistent increase in volume over time as a stock moves higher. This can indicate that larger investors, like institutions, may be involved with the stock. As they funnel their money in over time, it could mean the trend has staying power.
Charting the Ups and Downs in Volume
There’s an endless number of volume-based indicators that traders and investors can apply to trading. One way to get comfortable with applying volume is by plotting raw volume at the bottom of a chart. Once you’ve done that, adding a moving average to the volume itself will allow you to view volume in different time frames simultaneously.
There’s a simple way to add raw volume and a volume moving average in the thinkorswim® platform: the VolumeAvg indicator. Figure 1 shows the VolumeAvg indicator applied to a one-year chart at daily intervals. Along with a simple moving average based on volume, the indicator displays “up” volume days with green bars and “down” volume days with red bars.
With the VolumeAvg indicator, you can see days when volume spiked and how price reacted, as well as the overall trends in volume over time. With some practice, you’ll be able to decide when you see unique volume “footprints” from the past, and you can watch for them in the future as clues to what a stock may be up to.
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