Investing For The Rest of Us: Stock Market Volume

Details

Written by Glenn "Chip" Dahlke

Stock Market Volume, like other technical indicators, is used to predict short term trends in price movements of stocks. As a definition, volume is the number of shares traded in a certain security over some defined period of time. It can also be the volume of shares traded in a market index.

In its simplest form, volume is often thought to be a measure of liquidity in a stock. Liquidity is the ease to buy and sell. If a stock has heavy trading volume, that means there’s a lot of interest in that stock. Conversely, if there is little interest in a stock, it is said to be “thinly traded.”  Securities with light volume often have greater incremental trading price spreads. This is just a fancy way of saying that thinly traded stocks tend to have greater price volatility.

For predicting price movements, knowing about a stock’s volume is in itself fairly useless. It’s like having a stable without a horse.  To use volume correctly, we need to look at a couple things, the first being the volume trend.

Volume trend tells us whether the stock’s volume is increasing or declining. Either way, a trend depicts increasing interest or decreasing interest. Interest has nothing to do with price. You can have a steep upward trend in volume and declining prices. Maybe the entire executive class of a corporation is being sent off to prison. In the old days, they would jump out the windows, but now you can’t open the windows. In any case, having the president and his posse carted off to the nearest federal minimum security country club can cause lots of interest in a stock, much of it negative - volume up, stock price down.

Once we understand the direction volume is headed, we need to look at the volume in relation to price. Let’s take a stock with no real discernable volume trend and a price that is relatively flat. The company comes out with a new product that starts to attract some interest and investors start buying, driving the price up. Within days everyone wants to jump on board and the stock’s price keeps climbing and the volume of trades surges upward until the price becomes, well, a little pricey and interest to buy disappears. Volume declines dramatically. This becomes the signal for a price reversal.

For some people this concept of a reversal after a surge is hard to grasp, but, when you think about it, there’s a lot of sense in it. Say a hot new restaurant opens in town. This restaurant starts to get good reviews and reservations start pouring in. As the wait for a table grows longer, the reservations surge until it’s impossible to be seated. Now wait a month or two and call again. As if by magic, reservations are easier to get because the initial buzz has dissipated. Volume surge is not a lot different as either buyers or sellers pile on to drive up or down the price until the emotion evaporates. Once volume drops, look for the reversal.

A word about technical indicators - they are only indicators, not guarantees of future performance. My friend, Master Maine Guide, Randy Spencer, has a book out entitled, "Where Cool Waters Flow." The book follows his fishing and hunting experiences around the tiny town of Grand Lake Stream, Maine. In one section he gets into how wind direction affects fishing for small mouth bass. Wind direction for Randy is a technical indicator. However, as he muses later, some of his most productive guiding days are when the wind is blowing from a direction that should keep the fish off the flies. The same holds true for the stock market. Some of the best trades are done when the technical indicators are screaming for a day of rest.

So, remember, whether you’re looking for trophy fish, or trying to make a profitable trade, technical indicators can help, but they’re not the final word in success.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.

Glenn “Chip” Dahlke, a Senior Contributor to The Living Trust Network, has 30 years in the investment business. He is a Registered Representative with LPL Financial and a principal with Dahlke Financial Group. He is registered to transact securities business with persons who are residents of the following states: CA. CT, FL, GA, IL. MA, MD. ME, MI. NC, NH, NJ, NY.OR, PA, RI, VA, VT, WY. Securities offered through LPL Financial. Member FINRA/SIPC. Contact him at chipdahlke@dahlkefinancial.com or at his office on Ashlawn Farm in Lyme, CT (860) 434-4261.