Trading Volume and Price Reversals
Trading volume can also signal when an investor should take profits and sell a security due to low activity. If there is no relationship between the trading volume and the price of a security, this signals weakness in the current trend and a possible reversal.1
For example, suppose company ABC extended its uptrend for another five months and increased by 70% in six months. The investor sees that share prices of company ABC are still in an uptrend and continues to hold on to the shares. However, the trading volume is decreasing. This could signal to the investor that the bullish uptrend in ABC stock is beginning to lose momentum and may soon end.
The following week, the share price of ABC stock decreases by 10% in one trading session after being in an uptrend for six months. This results in the stock breaking its upward trend. More significantly, the trading volume spikes higher when compared to its average daily trading volume (ADTV). The investor sells out of all the shares of ABC the next day because the combination of a sharp drop in price and spike in trading volume confirmed that the uptrend might be coming to an end and a reversal might be in the offing.
Use Volume For More Trading Insight
- High or increasing volume in an uptrend can signal a buying opportunity.
- Decreasing volume in an uptrend may suggest that it's time to sell and take profits.
- High or increasing volume in a downtrend can signal that it's best to stay on the sidelines.
- Decreasing volume in a downtrend may indicate a coming reversal and a time to buy.
- More involved chart patterns, including the head and shoulders and the flag and pennant, use volume to confirm trends, reversals, and breakouts.2
What Is a Good Trading Volume?
Good trading volume for a security is hard to define because trading volume's value comes into play when looked at in context with other indicators, such as price direction and volatility. Any level of volume that provides investors with specific insight into a security's price action (and a sense of the trading interest in that security) can be thought of as a good trading volume.
What Does High Trading Volume Mean?
High trading volume (relative to past measures of that volume) that accompanies rising prices or an upward trend can signal strong interest in a security by buyers. On the other hand, high trading volume that accompanies dropping prices or a downward trend can signal worry on the part of investors. This can result in more selling and even lower prices. High trading volume could also reflect some isolated news or event related to the company associated with the stock.
Is Low Volume Bullish or Bearish?
Trading volume is defined as the number of shares traded in a particular period of time. So, low trading volume can indicate a lack of interest in either buying or selling. That means it could be bullish if low volume occurs in a downtrend. It could be bearish if it's noted in an uptrend.
The Bottom Line
Trading volume is one of the metrics that traders watch to predict the momentum of a stock or other security. An increasing trading volume might be a sign of favorable sentiment, indicating a likely price increase. A falling trading volume might indicate that the market is losing interest. As with other technical indicators, it is important to look at a broad range of metrics before making an investment decision.
