If you are trading or interested in trading, then you probably know the basics about volume. It represents the amount of shares traded in a given time frame, whether daily, hourly or even over 5 minutes.
The most common rule about volume is to only trade stocks meeting a certain minimum threshold of volume daily, thus ensuring liquidity and the ability to enter and exit the stock with ease. For me that minimum is generally 1 million shares per day, it’s a preference. That number can be higher or lower, but I’d suggest not falling under half a million shares in volume. The spreads on those stocks tend to be bigger and there is a lot of slack you need to make up for.
Now, it’s all well and good to use volume as a liquidity gauge, but what else does volume tells us in regard to trades and putting the odds in our favor?
Well, let’s think about it. Volume is produced by the transactions of buyers and sellers, which is driven by supply and demand. Through this supply and demand we can glean insight on whether buyers or sellers are in control of a stock and even whether a move is nearing exhaustion or has just broken out and begun.
Part of trading, and it’s something we stress in our teachings, is using trade setups to enter trades. If we look for certain trading patterns, say a reversal pattern, how do we know that there has been a shift in power? How do we know that in a down move the sellers have become exhausted and buyers are beginning to take control?
Granted we have a certain pattern and candlestick formation we are looking for, but is the volume confirming what we are seeing? Lets say after a stock moves down we get a long tailed reversal candle – now at that point we want to see a volume spike as part of that candle. This tells us that the sellers just gave what is likely their last final push and it failed to move the stock lower; the buyers ate up everything they had to offer and kept the stock from going lower. The balance of power has likely shifted.
Now if you were to see this same pattern and candlestick accompanied by less volume than prior candles, well that would likely lower the probability of the reversal following through as the sellers have not shown any sign of exhaustion and the buyers haven’t ramped up their efforts.
This is just one example of one pattern to help you get an understanding of volume analysis and how it helps us find better trade setups. Volume Analysis is one of many chapters we delve further into in the Active Trading Blueprint. You can use this link for more information: Active Trading Blueprint
Remember, “Victory Loves Preparation”