Understanding Unexpected Volume in Your Stock Trading

02/23/2009 10:08 am EST

Focus: STRATEGIES

S. Wade Hansen

Co-Founder, Profiting with Forex (PFX) and Learning Markets

Analyzing Stock Volume: Going Where the Crowds Are

When you are looking for stocks with the potential of making big price moves, it pays to go where the crowds are. Typically, when you can get a large number of stock traders interested in the same stock, you will see significant price moves.

As you will see in the Unexpected Volume video below, it's like trying to find the hottest new product. You want to look for the stores that have people lining up to buy whatever it is they are selling, not for the stores with empty parking lots.

What is Volume?

Volume is a measure of the number of stock shares that have been exchanged during a particular trading session. For instance, if the daily volume number for Apple (AAPL) is 25,000,000, it means that 25,000,000 shares of AAPL stock changed hands during the most recent trading day.

What Volume—Especially Unexpected Volume—Tells Us

Volume tells us how much market support there is for a particular price movement. Here are the four basic messages volume tries to send us:

1) Increasing volume pushing prices higher tells us there is a lot of support for the current price movement and the uptrend has a high likelihood of continuing.

2) Decreasing volume pushing prices higher tells us there is very little support for the current price movement and the uptrend has a low likelihood of continuing.

3) Increasing volume pushing prices lower tells us there is a lot of support for the current price movement and the downtrend has a high likelihood of continuing.

4) Decreasing volume pushing prices lower tells us there is very little support for the current price movement and the downtrend has a low likelihood of continuing.

How You Can Use Unexpected Volume

When you see stocks with unexpected volume, you can act on that information either by placing new trades or by protecting or exiting your current trades.

For instance, if you see a huge volume spike on Google (GOOG) and the price of GOOG shoots up, you may want to consider buying GOOG because the most recent move appears to have a lot of support behind it and will most likely continue in the future.

On the other hand, if you own ExxonMobil (XOM) and see a huge volume spike on it, and the price of XOM drops lower, you may want to consider selling your position in XOM—or at least setting a stop-loss order to protect your position.

Misconceptions About Volume

Novice investors will often say there are more buyers in the market when volume is high and the price of the stock is going up. They will also say there are more sellers in the market when volume is high and the price of the stock is going down. This, however, is inaccurate.

The stock market always has an equal number of buyers and sellers. For every stock that is sold, someone has to be on the other side of the trade buying the stock, and vice versa.

To be accurate, traders should say the price at which buyers and sellers are agreeing to trade is moving up or down. The number of buyers and sellers has nothing to do with it.

I've scratched the surface here in the article, but I go into more detail in the video below.

By S. Wade Hansen of PFXGlobal.com and LearningMarkets.com

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