Trading Volume and Technical Analysis
Trading volume is one of the most basic concepts to understand for the technical investor. The trading volume for any particular security is simply the number of shares or contracts traded in that security over a given period of time. In other words, a purchase or sale of that security creates volume. In general, higher volume, results in greater liquidity, narrower spreads and usually less price volatility.
What is Technical Analysis?
Technical analysis is an approach to stock trading under which the investor seeks to predict the future movement of a stock price by analyzing past data, primarily price movements and trading volume. For the pure technical trader, company fundamentals are not considered in their analysis, instead relying on such tools as moving price averages, relative strength index and chart patterns.
The Importance of Trading Volume to the Technical Analyst
Volume is of primary importance to the technical analyst as it is used to confirm chart patterns and trends. Price moves in either direction are seen as more relevant by technical analysts than if the move were accompanied by weak volume. Therefore, when a technical trader assesses a price move, they will look to see if the trading volume supports the perceived trend.
For the technical trader, there are several important premises:
(1) An increase or decrease in price supported by strong volume provides a good indication of the trend.
(2) An increase or decrease in price not supported by strong volume will lead the technical trader to question the legitimacy of the trend.
(3) Volume precedes price. So, if volume begins to decrease in an uptrend, it can signal that run upward is coming to an end. For this reason, volume is closely monitored by technical analysts in an effort to spot reversals of trends.
Watching for Unusual Trading Volume of a Security
Many technical investors see unusual trading volume of a stock as important information in making their trading decisions. In fact, many online services offer “Unusual Volume” as an indicator that can be tracked from their site. With such a service, a stock’s current volume is compared to its normal trading volume (often based on the last 50 days). This can help alert technical traders to the possibility of a new trend.
The NASDAQ Unusual trading Volume
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The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.
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