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Understanding and leveraging trading volume is paramount for traders seeking to navigate the complexities of financial markets. Volume, a key indicator, plays a crucial role in shaping market dynamics and influencing price movements. Traders rely on volume data to gauge the intensity of market activity, identify potential trends, and make informed decisions. Let us learn more about the importance of volume in the share market.
Table of Contents
Defining Volume in the Stock Market
Volume or trading volume in the stock market means the total number of shares that have been traded in a specific time period on the stock exchange/s. It includes the shares that are bought, as well as the shares that are sold during the time period. Generally, investors look at the daily volume, i.e., the volume calculated for a particular day. However, investors may also look at volume across other time horizons, like weeks, months, hours, or minutes, based on their investing strategy.
Let’s look at an example to further simplify the concept of volume. Assume that 1,000 shares of a company called XYZ are purchased at the start of a specific trading day. Before the end of the trading day, the buyer decides to sell 500 shares of XYZ. Also, assume that there were no other transactions involving the shares of XYZ on that day. In that case, the daily trading volume of XYZ’s shares on that particular day was 1,500.
- It doesn’t matter whether the same shares are repeatedly changing hands in the specified time period; those shares still account for the total daily volume.
- Volume can be determined for several financial instruments, like derivatives, commodities, and currencies.
- In India, the stock exchanges, the NSE (National Stock Exchange) and BSE (Bombay Stock Exchange) publish the volume numbers at the end of each trading session on their websites. They publish the total volume for individual stocks as well as for all the stocks traded on the exchange.
Importance of Volume in the Share Market
Indicator of Market Interest
Since volume in the share market is the total number of shares traded in a specific period, it tells us the traded quantity of the stock in that period. This said, the volume will be high if there is a lot of trading activity or when many shares are traded. This implies that there is plenty of interest generated around stocks, be it positive interest or negative interest. On the other hand, when the trading volume is low, the trading activity is low, or fewer shares have been traded. So, the volume indicates the market’s interest in a particular stock.
To further expand on the above points with an example, assume that the company comes out with blockbuster quarterly results, beating the expectations of the street. Looking at the positive earnings results, the stock gains traction and many investors start purchasing the stock. This will increase the trading activity around the stock, and that will reflect high volumes. If, on the other hand, the company was expected to deliver strong quarterly earnings but instead delivered results, the stock could see heavy selling activity. In both scenarios, the volumes may be high due to high trading activity, but the nature of the activity may be different.
Now, assume a scenario where a company is at the bottom of its business cycle. Here, analysts predict that the company won’t see significant positive growth in its earnings or revenues for at least a couple of years. In such scenarios, the market may tend to ignore such stocks for a while, resulting in a lack of trading activity in such stocks. So the trading volumes here may be low for a sustained period.
Indicator of Liquidity
Since a high volume indicates high trading activity, it also implies there are plenty of buyers and sellers in the market. Conversely, lower volumes indicate there are few buyers and sellers trading the stock. Hence, higher volumes also suggest high liquidity levels, while lower volumes suggest low liquidity levels.
Finding Volume on a Chart
One can easily get information regarding the daily traded volume on the websites of the stock exchanges. However, one can also find the volume on a price chart by adding the volume indicator to the chart. Usually, the volume indicator is added to the chart by default, and the volume is represented by vertical bars at the bottom of the chart. If it’s not visible on the charts, it can be added by clicking on the indicator tab or, in the case of the illustration, the ‘studies’ dropdown. The bars are generally green or red by default, as shown below on the chart of HDFC Bank.
In the above illustration, one bar represents the net buying or selling volume of a single trading day on a yearly chart. The green bars portray the net buying volume, while the red ones portray the net selling volume. In other words, green bars indicate that buying activity has been higher, while red bars indicate selling activity has been higher. In either case, a taller bar indicates higher trading volume and shorter bars imply less volume.
Relation of Volume and Price
Frequently, observers may notice a notable surge in stock prices within a particular timeframe aligning with elevated green volumes during that period. Conversely, a substantial drop may be reflected in a tall red volume bar for the same duration. It is essential to acknowledge, though, that a surge in trading volume does not invariably cause stock movements. However, a surge in demand can attract more buyers, potentially causing both a price increase and heightened volume. In such instances, high volumes may coincide with significant price upswings.
Volumes also help investors confirm the existence of a trend. High volumes, coupled with rising prices imply strong buying activity and healthy demand. On the other hand, high volumes coupled with falling prices indicate strong selling activity and declining demands for the asset. The former could be the start of a strong uptrend, while the latter could be the beginning of a downtrend or correction in the price.
Conclusion
Volume is a very useful indicator for both traders and investors since it helps to analyse the traded volume for both long and short time periods. When sharp price upticks accompany high volumes, it may suggest that ‘smart money’ or institutional investors are investing in the stock. At the same time, a long red bar coupled with a strong fall in the price of stock in an uptrend may suggest the peak has formed and a trend reversal is on the horizon. Hence, technical analysts mainly rely on volume to determine their entries and exits.