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Why is volume important in stock trading?

Why is volume important in stock trading? There is a straight and simple answer to this question – volume is important because it shows the strength of price movement. Like with most price phenomena in the stock market, we are concerned with changes rather than steady states so changes in trading volume are important signals.

This article looks at examples of changes in trading volume under different price movement conditions and draws general lessons and conclusions.

What is volume

Volume is usually taken to mean the number of trades in a stock in any one trading day. We talk about stocks that are thinly traded, if the volume is comparatively low and stocks that are heavily traded if the volume is comparatively high.

In fact some stocks and ETFs have consistently high trading volume and others have consistently low trading volume. Let’s remember though that trading volume is just the number of shares traded in any one day. There is another measure called dollar volume which is the number of shared traded multiplied by the price.

High volume examples

Among the companies whose stocks consistently trade with high volume are some major household names.

Bank of America Corporation, symbol BAC had an average daily trading volume of 81,891,232 and an average daily closing price of $25.29 in June 2020. Here is what that looks like.

BAC candlestick and volume June 2020

1)Data source for all charts Yahoo Finance, or ETrade. Charts and calculations were prepared by https://badinvestmentsadvice.com/

General Electric Company, symbol GE had an average daily trading volume of 103,510,318 and an average daily closing price of $7.21 in June 2020 and this is what that looks like on a chart.

GA candlestick and volume June 2020

Those are both large-cap blue chip stocks that have been among the highest volume traded stocks on US markets for many years. Lets’ take a look at another high volume stock.

Apple Inc is one of the leading mega-cap stocks of the technology sector which has itself been leading the market advances of recent years. Apple Inc, symbol APPL had an average daily trading volume of 35,851,786 and an average daily closing price of $345.81 in June 2020. Here is the chart for Apple Inc in that month.

APPL candlestick and volume June 2020

To make a bit more sense of these we should put the price and volume statistics into perspective.

Dollar volume with respect to market capitalization

In June 2020, Bank of America average closing price was $25.29 and the average daily volume was 81,819,232, so the dollar volume was $2,070,908,366 which equates to around 0.97% of its market capitalization of $213,420,000,000.

General Electric Company, with an average closing price of $7.21, daily volume of 103,510,318 meant a dollar volume of $746,273,401 which is around 1.19% of its market capitalization of $62,454,000,000.

In comparison, Apple Inc. had an average closing price of $345.81 daily volume of 36,851,786 so a dollar volume of $12,743,582,115 which is around 0.75% of its market capitalization of $1,694,000,000.

So those large and very large-cap companies all trade with a volume that results in a dollar volume is around 1% of the market capitalization. Let’s take a look at an actively traded small-cap stock.

Calyxt Inc. symbol CLXT is a small biotech company involved in gene splicing plants mainly for agricultural purposes. It is one of those small biotech companies working with genome splicing or CRISPR technology which is one of today’s ‘hot topics” for investors. It has a market capitalization of $150,665,000. In June 2020. Here is the chart of its share price and volume in June 2020.

CLXT candlestick and volume June 2020

In June 2020 Calyxt Inc had an average daily volume of 83,841 and an average closing price of $5.19 meaning an average dollar volume of $435,211 which is just 0.29% of its market capitalization of $150,665,000. On the thinnest day of trading the volume was just 23,300.

This highlights a potential problem with small-cap stocks, Trading volume can collapse. So even if your crystal ball works wonders and you jump into a small-cap that appreciates nicely, you still need to know that on the other side of the gain there will be enough liquidity for you to get out.

The generally accepted wisdom regarding small-cap stocks is to look at average volume over a good three-month period. The definition of a small-cap stock is not fixed. I have found it wise to be careful with anything below about $150 million in market capitalization though most brokerage houses would consider that to be already micro-cap.

Volume – a recent example

To take a closer look at trading volume, here is a chart of the price of the State Street Global Advisors fund that tracks the Standard and Poor’s 500 index, pr S and P 500 for short by the symbol SPY for the period July 2019 through to mid July 2020.

SPY Jul 2019 to Jul 2020

As many of us know, through 2019 we saw the market steadily climb to a peak on 19 February 2020. The S and P 500 reached 3,386.15 and SPY closed at $335. Both then dropped dramatically to a low on 23 March 2020 when the S and P 500 reached a low point of 2,191.86 and SPY closed at $222.

What is interesting is noting the trading volume that accompanied these dramatic price swings. Let’s take a look at SPY for a five-year period prior to mid-July 2020. Here is what that looks like.

SPY 5 years to Jul 2020

It is interesting to note the patterns in trading volume. It brings us to the main point of this article.

If upward price movement is accompanied by increasing trading volume then that shows that the upward movement is strong and is likely to continue.

If on the other hand there is an upward movement in price and the daily trading volume starts to decline, that shows a weakening price trend and may indicate that a trend reversal is on the way. We can see this on both charts at the 19 February 2020 peak. The daily volume on the SPY dropped noticeably lower just before the market tanked.

SPY 5 year close up

We are looking at the 5-year chart as well to put the daily volume in February 2020 in context. Going back 5 years we can see that the even though the index was in new highs the volume would still shrink noticeably in February 2020. Here is a closer look at that exact period.

SPY Jan to Mar 2020

If we look back at the average daily volume over different periods for the SPY this is what we see.

  • July through December 2015, average volume 132,180,889
  • January through December 2016, average volume 104,724,339
  • January through December 2017, average volume 70,457,158
  • January through December 2018, average volume 97,164,471
  • January through December 2019, average volume, 70,032,142
  • January through 19 February 2020, average volume, 62,732,615

Noting that the SPY hit its all time high on 19 February 2020, with weak volume the subsequent price collapse seems justified.

Volume compared with MACD and RSI

Let’s take a look at the SPY for the same period, comparing the price movement with volume, the Moving Average Convergence Divergence, or MACD for short and the Relative Strength Index or RSI for short.

SPY Oct 2019 to Jun 2020 Price Volume MACD and RSI

Buy and sell signals from the MACD have been examined here, similarly how the RSI can be an indicator of price trend momentum here.

I know that wisdom in hindsight is easy and this is only looking closely at one single price movement but I do think it is fair to note that the drop in trading volume at the price peak was a strong signal, confirmed a few days later by the MACD crossing over its signal line.

As regards the RSI, this is more valued as a limited indicator of continuation of a price movement rather than indicating a reversal. In fact, it was suggesting that the SPY was already overbought in December 2019 and January 2020.

Answers to common questions

  • Why does volume matter in stock trading – the strength of volume is an indicator of the strength of price movement.
  • How does volume affect trading – if volume is increasing traders expect the price movement to continue. If volume is decreasing traders expect the price movement to weaken and reverse.
  • Is volume good or bad for stock trading – volume is an indicator of whether price movement will continue or reverse.
  • What happens when stock volume increases – when stock volume increases, price movement whether trending up or trending down is likely to continue and strengthen.

Here is a single-page summary of this article. It is available for download here.

Volume in stock trading summary


I hope you found this article interesting and useful. Do leave me a comment, a question, an opinion or a suggestion and I will reply soonest. And if you are inclined to do me a favor, scroll down a bit and click on one of the social media buttons and share it with your friends. They may just thank you for it.


Disclaimer: I am not a financial professional. All the information on this website and in this article is for information purposes only and should not be taken as investment advice, good or bad.


Affiliate Disclosure: This article contains affiliate links. If you click on a link and buy something, I may receive a commission. You will pay no more so please go ahead and feel free to make a purchase. Thank you!


References

1 Data source for all charts Yahoo Finance, or ETrade. Charts and calculations were prepared by https://badinvestmentsadvice.com/

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16 Comments

  1. Hello Andy, awesome and thank you for sharing this great informative article. I haven’t invested in the stock market before as I don’t really know about it in details. I have seen the stock market index but didn’t know what it is, therefore didn’t really make use of the information. After I read your article it has helped me to have a better understanding of the stock market indexes. Thank you very much for the information. May be it is soon time for me to invest on stocks. Does one need a bigger capital in order to invest on stocks?

    Juma

    • Hi Juma and thanks for your comment. I am glad you found the article informative. On the subject of marketing indexes, the preceding article takes a closer look at how some of them work. Here is the link
      https://badinvestmentsadvice.com/what-is-an-index-in-the-stock-market/
      As regards how much you need to start investing in stocks, in today’s world it is very easy to invest in stocks. There are a number of large brokerage companies that will help you open an account with no minimum and you can buy and sell most stocks and ETFs. From a practical perspective, you can start with a little as $100. Here is another article that compares some of the major brokerage companies.
      https://badinvestmentsadvice.com/best-trading-platform-for-beginners-a-comparison/
      I hope this helps. Do let me know if you have any further questions, comments, or suggestions. Best regards, Andy
       

  2. Thanks Andy, I have not bought shares for a long time now so this is interesting although I don’t profess to know any of the in and outs of the trading market. However I think after reading your article I think I understand more about the volume trends and risk.

    On  a personal note I do find this market shouting out to a lot of people who just don’t know where to start. I just moved my pension for that very reason, the language they spoke made no sense, I didn’t think they cared and my new provider makes it easy for me to understand, I think financial services are missing out on this big time.

    So I am a big supporter of articles like this, anything that makes things understandable  we are not involved day to day is helpful.

    It feels this is what market disruption is about and your article is part of that. I am a big fan of market disruption where suddenly the customer is in the driving seat.

    • Hi Phil and thanks for the comment and positive feedback. I am glad you found this article informative. There are indeed a number of pitfalls in investing. I am reminded of an experience shortly after coming to the US and joining my employer’s 401k plan. I came from Europe where as individuals we typically had little control over how our pensions were invested. I think this was around 1999 or 2000. I had started the plan paying into I think a large-cap growth, and emerging markets, and something else. These were all Nationwide funds and our choice was limited. Then there was a major market correction, the dot com bubble I think and all my colleagues, including our finance manager who already had much more in the plan than me, started moving their 401k plans around out of funds that had been hit hard and into “safer” more conservative funds – all with the same provider though. I didn’t because I thought the horse had already bolted so pointless to close the barn door. Over the years I have realized more and more that I was correct. I am just recounting this tale as I think many of us are prone to make similar reactive moves. What tends to happen is that by being reactive we are likely to move out of higher risk higher reward funds just before they recover and deliver better than average returns. Thanks again for your comment and I hope things work better for you with your new pension provider. Best regards, Andy

  3. Wow what a thorough article on stocks and trading. 

    I thought about getting into some trading and investment in the stocks, for example, the cruise line I work for, but don’t know much about it and got lost online searching for the answers. Your article helped me understand some parts of it, for example, indexes. 

    Now I would like to ask you, what would be your recommendation for the amount (volume) you start with? 

    • Hi Sunny and thanks for your comment. I am glad you found the article informative. I think your question relates to position size and not so much daily market trading volume. If you are looking to make an investment in a stock, the size of the position you take is more determined by how much you are willing to lose if the investment goes bad. Position size is a whole subject in itself and there is no simple answer. The factors to consider are the price volatility of the stock, how many positions in other investments you have, or want to make how sensitive the stock position is to market risk and how the other investments you have, are or are not correlated with market risk. As regards the cruise line industry, it has been hammered pretty badly by the COVID situation,. I would have thought that many clientele would no longer wish to take cruises because of the risks of infection. On the other hand, they say that buying a stock on bad news is often a way to buy when the stock is low in price. So if you are convinced that the setback is temporary it may be a good time to invest. As I say this may not be the answer you were hoping for but it may give you some things to consider to make your decision. Best regards, Andy

  4. Hello Andy, these days many people have been making money by trading online. I am fortunate to have been really lucky at it. I really enjoy getting to learn more details about how stocks and the market works and I would love more of such articles on your really good website. In your opinion is trading volume more important than trends shown by moving averages, or is there another indicator that we should be paying more attention to.?Thanks for sharing 

    • Hi Bella and thanks for your comment. I am glad you found the article useful and congratulations on your successful trading activities. As regards whether the trading volume should be considered more than other indicators, I would say that it is one of the most fundamental aspects of stock trading and you always want to have an eye on volume. Volume can be one of the best ways to spot the trading activities of institutional investors. From that perspective alone volume is very important. Thanks for the question and comments and best regards, Andy

  5. Thanks for your informative post. I have traded stocks and kept an eye on volume to help me solidify my decision to trade or not. When volume is weak, I avoid trading as there is very little momentum and therefore direction if the price movement. 

    The trick is to get a position just before volume takes off. It is not easy to decipher when this happens. The alternate is to get in as soon as one sees volume starting to spike. 

    Edwin

    • Hi and thanks for your comment. It shows you have practical experience of how to read trading volume and adjust your trading activities accordingly. I have found the same. You really do have to pay close attention to catch these signals as they tend to show themselves right at the very last moment if at all. I find it also useful to watch the ADX indicators which track the rate of change of volume as well. Thanks for the great comment. Best regards, Andy

  6. Hello Andy, awesome and thank you for sharing this great informative article. However, after reading your article I think I understand more about the volume trends and risk. I am into stock trading since many years. But, I don’t claim myself pro. I came across the word volume but never went into it deeply. Thanks for sharing such an insightful content.

    • Hi Rajesh and thanks for the comment. The more I look into this the more I find that trading volume is indeed one of the important indicators to watch for. Changes and signals can be hard to detect. After all, this is one of the areas where it is possible to see the activities of institutional investors. So it is well worth keeping an eye on volume. Thanks for a great comment and I wish you success in your trading and investing. Kind regards, Andy

  7. Hello there, Trading volume indicates the overall activity of a stock and its momentum, and it is an important technical indicator used by investors to look at stock trends. The volume gives investors an idea of the price action of a security and whether to buy or sell the security. Thanks a lot for sharing this awesome article i know it would be of great help to us all.

    • Hi and thanks for the comment. I am glad you found it useful. Best regards, Andy

  8. Hey there, before reading that article I was asking myself what kind of volume are you talking about and as soon as I started reading the article my question was answered like how you explained everything in your article thank you so much it left me satisfied without any questions.

    • Hi and thanks for the comment. I am glad that you found it clear and informative. Best regards, Andy

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