Volume is considered to be an important tool for a stock trader to analyze because it gives a lot of insight towards the price movement of a stock. But what is volume and why is it important for stock traders?
What is stock volume?
Volume refers to the total number of stocks which have exchanged hands in a particular time frame. Here is a chart of Reliance Industries which shows the volume of stocks traded (at the bottom) on a daily time frame.
Volume can fluctuate up and down depending on the interests which the traders have in a particular company on a particular day. If a company is about to make a major corporate announcement, there are high chances that the volume for that company will be very high because many traders will be interested in the stock. On the other hand, volumes can be low when there is no buzz about the company.
The exact amount of stocks traded on a particular day can be checked using the volume bar which is generally present at the bottom of most stock chart applications. It can be seen that around 60 Lakh shares of Reliance Industries were traded on the last trading day.
Now that we know what volume means in terms of stock trading, you must be wondering why is volume important?
Why is volume important?
Volume provides us with key insights about the strength of the stock movement. First, it provides the information about whether a particular stock is attracting a lot of traders or not. Like previously mentioned, high volume in a stock can mean that something significant such as a corporate announcement, quarterly result, stock split, issue of bonus share, etc. is being done by the company. This can provide us with useful information about the behaviour of traders towards any news or corporate announcement. However, trading should not be done simply based on stock news. To learn more, visit this article!
Secondly, if the price of a stock changes significantly (regardless of whether it goes up or down), then the strength of that move can be determined by the volume of the stocks traded during that time frame. If the stock movement is accompanied with high volumes, it is generally a stronger move and is most likely sustainable. On the other hand, stock movements with low volumes are generally considered weak and can easily reverse.
What the majority thinks, matters!
Let’s take an example to understand about volume. Suppose a committee of 1000 people are supposed to gather and take a decision on an issue by voting. But during the voting day, only 50 members out of 1000 showed up! Those 50 members completed the voting and took a decision based on those votes. There is a very high chance that this decision will be challenged by the committee because only 5% of the people voted and took the decision for the entire committee.
If instead, 600 people showed up during the voting day and took the same decision on behalf of the committee, then there is a very high chance that the decision will be accepted by the entire committee because the decision was made by a big ‘volume’ of people. The wishes of a higher percentage of people were considered when taking the same decision.
The exact same thing happens in stock trading! Whenever the price of a stock changes then regardless of the volume of the stocks traded, the price of every single stock gets changed. If the change in price is accompanied by low volume of the stock, there is a high possibility that the remaining majority will not accept the decision and reverse the price movement. But if the change in price is accompanied by a high volume, there is a high possibility that the majority accepts the price movement of the stock. So the chance of reversal in price movement gets reduced.
A word of caution
It should be noted that there is no such rule that price movement which is accompanied by high volume cannot be reversed. It is entirely possible that the same traders who were buying the stock changed their minds and started selling the stock the very next day due to some new developments. But volume acts as a very reliable measure to inform a stock trader about the strength of the price movement of the stock. Volume should be used only as one of the tools & not the only tool when analyzing stock charts.
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All charts in this article are shown by using Tradingview!
DISCLAIMER : I am not a financial advisor. I am not for or against any company which I have mentioned in this article. All the information provided here is for education purposes. Please consult a financial advisor before investing.
Contact me at investmentabshuru@gmail.com
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