Finding success in the stock market is no easy feat. It requires utilizing all the tools and knowledge at your disposal. The market can be volatile and extreme, so it’s essential to understand all the metrics you have as a trader to decipher which trades are worth the investment and which are not.
One of the most critical metrics out there is a stock’s volume. Volume represents the entire number of shares sold or purchased during a specified trading session. It indicates a birds-eye-view of the health of a particular stock during a given time frame.
While volume doesn’t directly affect price, it indicates trends and dramatically affects the way that shares move. In other words, it can indirectly affect price, but it cannot change it directly.
Let’s take a look at how a stock’s volume can affect trends and movements and how you can utilize this metric to increase your odds of stock market success.
The Impact of Volume on Stocks
Like any other market in the world, the stock market is simply a market. Like all markets, it functions on the principles of supply and demand. Often, when there’s a high demand for a particular stock but low volume, the stock’s price is higher. On the other hand, if the volume is high, but there’s lower demand, the stock’s price is lower.
However, like all things in the stock market, it’s not always this straightforward. Several factors go into identifying a stock’s value. For instance, an active trader might value the bid-ask spread over the stock’s base price.
Regardless of how you value your stocks’ worth, the volume is always a useful metric. High volume results in better bid-ask spreads and higher base prices.
The more you begin to analyze volume, the more you’re able to see how substantially it impacts a stock’s value.
Volume’s Effect on Liquidity
If a stock lacks volume, then it also lacks liquidity. Liquidity is simply a measurement of the ease at which you can buy and sell stocks. If a stock lacks volume, then there are no stocks to sell or buy. Attempting to work with a stock that doesn’t have volume is like trying to surf when there isn’t any water. It’s virtually impossible.
When day trading, liquidity and volume are crucial metrics. While day trading, your goal is to focus on high volume stocks with lots of liquidity, because your success depends on how easily you can buy and sell stocks. Low volume stocks can ruin your chances of success as a day trader, so you want to avoid them.
Volume does more than measure liquidity. It also gives insight into the health of a stock.
The Importance of Momentum
When a stock’s volume rises, the value of that stock tends to increase as well. This is because rising volume tends to indicate momentum.
Essentially, if a company’s stock volume rises rapidly, it can indicate that its overall value is also increasing. These signs mean that the company is gaining momentum in the market. However, this isn’t always a surefire sign because sudden boosts don’t always indicate permanent upward trends.
The best way to gauge momentum is by looking at the company’s history and seeing if there’s been a steady increase in volume. If so, chances are the stock will continue to rise.
However, how do you know when momentum is falling?
Pay Attention to Volume to Know When to Sell
Let’s say that the same company from above continues to increase in volume. Over the next year, more people purchase stock, and the volume and price continue to rise. Then, you notice that the stock’s price continues to increase, but the volume stops rising.
If people stop buying and selling the company’s stock even though the value is high – it’s a good indicator that it’s time to sell and get out.
Volume’s Effect on Your Success
While volume may not directly impact price, it sure does influence the way the stock market moves. It impacts liquidity, highlights momentum, and gives a clear indication of when a stock might be poised for a drop.
Keeping an eye on volume helps ensure that you know when to buy and when to sell. Ultimately, whether you’re day trading or long-term investing – volume is an important metric to understand.
Skylar Hammond is a writer for the True Trader group who specializes in topics such as stock trading, personal finance, and forex. He focuses on helping beginners and experts alike learn more about the market and improve their trading skills.