Trading Volume as a Market Indicator
Traders often use volume—which measures the number of shares traded during a particular time period—as a way to assess the significance of changes in a security's price. For example, volume can help confirm price trends that have already formed or serve as a warning for a potential trend reversal.
While not every large increase or decrease in trading volume is significant, it can potentially give you a sense of the true strength behind a price move. The idea is that above average and/or increasing trading volume can signal that traders are truly committed to a stock, while below average and/or decreasing volume can signal a lack of enthusiasm among traders.
In this article, we’ll take a closer look at how to use volume indicators as a confirmation or a warning signal for changes in a security’s price.
Market indicator signals: What traders look for
When using volume, traders look for either confirmation or non-confirmation to help confirm or deny the possible strength or direction of a trend.
- Confirmation (Chart 1): Volume increases as the stock trends in either direction.
- Non-confirmation (Chart 2): Volume does not increase or actually decreases as the stock trends upward.
Bullish signals from trading volume
Upside breakout accompanied by larger than average volume (confirmation of trend strength)
During uptrends and in sideways markets, a stock’s price will occasionally run into a resistance level. When the price breaks above resistance, the breakout is generally believed to be more significant if volume is high or above average. A breakout accompanied by low volume suggests enthusiasm for the move may be lacking.
Uptrend accompanied by increasing volume (confirmation of trend strength)
An uptrend with increasing and/or above average volume implies investor enthusiasm for that stock or asset is strong, which could lead to more buying and even higher prices.
An uptrend without increasing and/or above average volume suggests investor enthusiasm is limited. While the price could continue to rise, many traders who use volume analysis will still look for other candidates.
Bearish signals from trading volume
Downside breakout accompanied by heavy volume (confirmation of trend weakness)
During downtrends and in sideways markets, a stock’s price will occasionally run into a support level. When the price breaks through to the downside below a previous support level, the breakdown is generally believed to be more significant if volume is high or above average. A breakout accompanied by low volume suggests enthusiasm is lacking.
Downtrend accompanied by increasing volume (confirmation of trend weakness)
A downtrend accompanied by increasing and/or above average volume implies investors have doubts about the stock, which could lead to more selling and even lower prices.
A downtrend without increasing and/or above average volume implies investor concern is limited. While the stock’s price may continue to fall, traders who use volume analysis may start to follow the stock and watch for signs of a pickup that is supported by increasing volume.
Trading volume as a measure of investor sentiment
Volume reflects traders’ actions in the marketplace and as a result can be a very useful measure of sentiment. As a rule of thumb, any price breakout or trend that is accompanied by above average volume is considered to be of potentially greater significance than price movements that are not.