Importance of Volume in Technical Analysis

by J Victor on December 2nd, 2010

Volume is simply the total number of buyers and sellers exchanging shares over a given period of time, usually a day. Higher the volume,  more active the share. The data regarding volume of a share will be readily available on your online trading screen. Most financial sites carry data about volume.

For example if the Stocks volume for the day was 1,500,000 shares that means 1,500,000 shares were sold by someone and bought by someone on that day.

Volume as such may not be an attractive piece of information. But try to combine the volume data with support and resistance levels – you‘ll get the real picture.

For example Say stock A ltd broke a ‘resistance level’ and went up further. Also since it broke through a critical level we would expect it to go up even more in the near future.

Now, let us also consider the volume traded on that day – say 3 lakh shares were exchanged.  On a normal day 1o lakh  shares are traded. That means, Volume was way below average for that day. So, all the big investors were not trading.  They could come in the very next day and decide they are bearish on the stock. They sell and cause a panic. So the stock goes down the next day.

This is the importance of ‘volume’. Most traders will not buy a stock when it breaks a critical level unless volume is high. The reverse is also true. If a stock goes down with little volume it could mean the same thing.  The majority of investors were not trading.  When they come back they could see this stock and decide it is too low. So they buy it and the price goes up.

In short, Volume is a critical factor in technical analysis. Any support and resistance level is not valid unless it is backed by adequate volume. Volume should move with the trend. If prices are moving in an upward trend, volume should increase (and vice versa). If the previous relationship between volume and price movements starts to deteriorate, it is usually a sign of weakness in the trend. For example, if the stock is in an uptrend but the up trading days are marked with lower volume, it is a sign that the trend is starting to lose its legs and may soon end.

TIPS ON VOLUME ANALYSIS

• Investors must always look at price patterns in conjunction with their associated volume pattern, never alone. A stock may appear to go up but the volume pattern must confirm that analysis
• Careful analysis of the volume of selling that occurred above current resistance will help you estimate how long a stock will stall at that level
• Well-above-normal volume is essential when separating a true from a false breakout above resistance.
• If a stock is truly in a healthy uptrend, then volume should rise as prices rise. If this is the case, then the volume indicates that buyers are chasing the stock. This increases the probability that the uptrend will continue.

Hope you are now clear about volume and its importance.

In our next series of posts, we will look at some basic price chart patterns and their meaning.

Till then,

Have a nice day.

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