What is Volume?

Looking at the volume of a company’s stock is like looking at the sales in a store…

A higher volume of sales in a store is a sign that the products the store is selling are in demand. Similarly, the volume of a company’s stock tells investors how much in demand its stock is and how easily they may be able to buy or sell the shares.

Volume represents the total number of stock shares or options contracts that change hands, usually during an individual day. Volume can be calculated either for a particular stock or for an entire market.

In the stock market, volume looks at the number of shares traded, not the number of transactions. Suppose that in a single sale, one investor sells 100 shares to another investor. The volume increases by 100, not just one. However, in the options market, if an option to buy 100 shares is sold, volume increases by just one transaction, not by 100.

Volume can be an indicator of market trends and developments. Suppose a company releases a new earnings statement, which shows a steep increase in revenue. This announcement puts the company in the spotlight; it could encourage investors to buy more of its stock, and volume increases. Or, if the company announces bad news, like earnings that aren’t as high as expected, more shareholders may sell the stock, which can also increase volume. The volume (in particular average volume) can also be an indication of how liquid a particular stock or market is, or how easily you can sell an investment for its market value.

Volume can also clue investors in that something is happening at a company that they may not know about. If a stock’s volume suddenly rises and there isn’t an apparent reason, like an announcement from the company, it could suggest there has been a development affecting the company that some investors know about but not others.

Volume can also help investors evaluate whether the movement of a stock’s movement is valid and likely to be lasting. If the price moves up or down and volume is high, with lots of people trading it, that’s a bigger “sample” that suggests the movement strongly reflects the market’s sentiment about the stock. If the price moves but volume is low, however, there’s a greater possibility the movement is simply random, or not representative of the market’s true sentiment.

Volume tells you the level of activity, but not the reason behind the activity.

Suppose your local retailer is selling a new brand of shoes. There’s a lot of demand — Boxes are practically flying off the shelves. Volume is high. But then suppose it drops off. That could indicate demand for the shoes has gone down, and consumers suddenly have stopped buying them. But it could also be that the retailer has decided to stop selling the shoes. Volume looks the same either way — You don’t know why it changed.

The volume of a particular stock works like that. A decrease in volume could represent a decrease in demand for the stock, but it could also represent a decrease in supply, meaning the people who own the shares don’t want to sell them. Or sometimes the reason for an increase or decrease in volume isn’t evident at all.

Calculating volume for a stock or an option is easy — It’s merely the sum of all of the shares or options contracts that changed hands during a specific period, usually a given day.

The various stock exchanges such as the NASDAQ and New York Stock Exchange publish daily information about the volume of stocks, and the information is typically available via many providers of financial data and news organizations that follow business and financial news.

A volume chart shows the volume of a particular stock or market over a period of time. Investors can use volume charts to look for trends, which can help them make buying and selling decisions. If trading volume rises, that suggests there’s more interest in that stock.

There’s no hard and fast rule as to what “good” volume is — It will vary from one stock to another. Looking at how the volume of a particular stock changes over time is more important. You can see that with volume charts that show the historical data for a stock’s volume.

Volume can help investors to analyze trends in the market. Suppose the price and volume of a particular stock have been high for many months. If investors see that volume has started to trend downward, they may take that as a sign that a decline in the price is also coming.

Also, an increase in volume can often be the result of some news that has drawn attention to the company. So a volume increase - often accompanied by a rise or fall in the stock price - might prompt investors and analysts to check whether anything is happening.

The importance of volume will vary depending on your investment goals.

For example, if liquidity is what you’re concerned with, volume is probably significant only if you’re purchasing a large number of shares of a stock. If you’re only buying a few shares, it’s likely to be easy to sell them at any time.

It also depends on how long you plan to hold the stock. Suppose you’re looking for investment opportunities for your individual retirement account (IRA) that you can put your money in and let it sit for years. Volume would be far less critical because you aren’t planning to sell your shares anytime soon. On the other hand, day traders who buy and sell stocks quickly should be far more concerned with a stock’s volume, because it’s an indication of how easily they can do so.

Besides the daily number of shares traded, analysts might also use indicators that relate volume to other factors. Of course, there is no guarantee that these indicators will accurately foretell where a stock or the overall market are headed.

On Balance Volume (OBV): OBV calculates the volume of a particular security in relation to whether its stock price is rising or falling. It’s an indicator of momentum that’s used to predict the future direction of a stock’s price.

Volume Relative Strength Index (RSI): RSI uses changes in the volume in either direction to help determine whether the market is bullish or bearish. If the up-moves are stronger, then the stock is bullish. If the down-moves are stronger, then the stock is bearish.

Volume Price Trend Indicator (VPT): The purpose of VPT is to indicate the strength of a stock’s momentum based on its volume and the increase or decrease in its price on a percentage basis. Analysts use this indicator to determine which direction a price is expected to move and how strong the move will be.