Volume is an important technical indicator to pay attention to. Understanding the relationship between price and volume can be a useful skill for both day traders and long-term investors.
Understand the relationship between price and volume using the VolumeAvg indicator
Sometimes we take things for granted without realizing their importance. Take volume as an example. Most technical indicators or studies are based on price or volume data, yet price always seems to get more attention. That’s probably because price directly affects portfolio values. But understanding how to interpret volume (vertical bars you sometimes see below the price chart) is a skill that could 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.
Remember: Volume is a reflection of the number of trades (buys and sells) for a price bar. In a way, it’s an expression of emotion, that is, fear and greed. Volume spikes during an uptrend can indicate optimism or euphoria, and volume spikes during downtrends could indicate fear. But what is high or low volume? Some stocks may have higher average trading volume than others, so it can be helpful to compare trading volume to the average daily volume. This can indicate whether volume is high or low on a relative basis.
How you interpret volume has a lot to do with your trading preferences. If you’re a day trader and are watching a stock you think is going to break out of an intraday pattern, then you might consider looking for a spike in volume to accompany a price move. It might be a merger or acquisition, earnings, or any other event, and once it’s over and the breakout is complete, price may continue moving higher even without a continued increase in volume.
On the thinkorswim® platform, bring up a chart. Select Studies > Add study > All Studies > V-W > VolumeAvg.
Want to change the parameters of the moving average? Select the indicator and then Edit study VolumeAvg(50). In the VolumeAvg Customizing window, select the VolAvg tab under Plots and under Inputs and Options, change the length of the moving average.
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.
There’s an endless number of volume-based indicators that traders and investors can apply to trading—including On-Balance Volume, Volume Oscillator, and Volume Profile. 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 from TD Ameritrade: the VolumeAvg indicator. Figure 1 shows the indicator applied to a one-year daily chart. Along with a simple moving average based on volume (yellow line), the indicator displays “up” volume days with green bars and “down” volume days with red bars. The default period for the moving average is 50, but you can go in and change the parameters.
FIGURE 1: SPOTTING THE SPIKES. The VolumeAvg indicator can help traders and investors identify spikes in up and down volume and track the overall trend and investor sentiment. Look to see if the volume spikes correspond with big price moves. Chart source: The thinkorswim platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.
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. The two work together and are the basic data points traders and investors can work with. 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, even though what happened in the past doesn’t necessarily play out the same way in the future.
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