Opening a treasure chest
Learning to properly analyze trading volume is crucial if you want to make a lot of money in the markets. The skill of recognizing whether the bulls or bears are in control of a particular market, is almost like having a key to a treasure chest of virtually unlimited money.
The definition of trading volume
It is the number of shares or contracts traded in an individual security, or an entire market during a specific period of time. Basically, it is the amount of shares that trade hands from sellers to buyers as a measure of market activity. As an example, if a buyer of a stock purchases 200 shares, that would cause the volume for that period to increase by 200 shares based on that transaction.
If you get a big price gain in heavy trading volume, this tells you big players such as mutual funds and hedge funds most likely are buying. On the other hand, if you get a big price drop in heavy volume, it is pretty clear the big players are selling. A big price gain in light volume gives you an indication there is a lack of conviction in the move. Big players simply are not behind the move, and the stock will have a hard time holding onto its gains.
Supply and demand
Price-action is obviously important, but trading volume, the supply and demand, will best tell you what is actually going on with a stock, or the market as a whole. Our objective is to determine the balance of the supply and the demand. When the demand is greater than the supply, the price will rise, and vice versa. Remember, it is the action of the volume that tells us of the supply and demand. The price only gives us the value of the volume.
3 important types of trading volume activity
The first type is increasing volume during a price advance, with pauses or set-backs occurring on light volume. This type of action is indicative of demand being greater than supply. This is the type of price and volume action that favors a resumption of the advance. You will make excellent money if your stock is showing this kind of price and volume action.
The second type is when you get increased volume at the top of a price advance, and it lasts for a while with no meaningful gain of prices, that is called churning. Many times churning is indicative of a turning-point. Big players are getting rid of their shares right before the general market starts a correction, or even possibly a bear market. This type of action usually fools the general public.
The third type of trading volume has to do with a price advance that is struggling or acting very tired. This is the case when you see a stock, or the market in general, creep upward on light volume, and simply dies at the top. Basically, this indicates a lack of demand. There are few buying orders or selling orders. This action many times is telling us a reversal could soon be in the cards, especially if followed by increased volume on the down side. Heavy volume at the end of a move generally means a turning-point. Recognizing reversals or turning-points can make you a fortune.