What Is Volume?
When you think about it – that really is a great question. First, lets begin by defining volume. Volume simply is the total number of shares traded in one period (minute, hour, day, week, month, etc) Remember there are two sides to every trade. Every tick is comprised of a buyer exchanges shares with a seller. So there must be a minimum of two shares for every trade.
Why Is Volume Important?
Institutional investors (a.k.a very large investors who dominate the market) buy and sell millions of shares every day. These investors are important because when a large group of institutions begin buying the same stock- the stock almost always goes up. The same is true when a large group of institutions dump a stock (it almost always goes down). Technical analysis 101 tells us that all things equal- it is healthy to see volume expand with the broader trend and contract on retracements. Or, put another way, in up markets it is healthy to see volume expand when the market rallies and contract when it declines. The opposite is true in down markets.
Volume Is Often Misunderstood:
The problem with most conventional wisdom is that most people believe it and it does not always work (most people fail to beat the S&P 500 each year). In fact, my research shows, there is no viable correlation between volume and strong moves in the market or leading stocks. Don’t believe me? Take a look at the chart below.
Let The Facts Speak For Themselves:
The stock market has soared over the past 5.5 years and volume has steadily declined. How is that possible?. Take a look at the annual chart of the S&P 500 over the past 5.5 years. We are in one of the strongest bull markets in history and volume has steadily contracted. The same is true for countless leading stocks.
So What Determines Price?
At the end of the day volume does not determine price. The number of buyers vs the number of sellers determines price. For example, if there are very little sellers, a market (or a stock) can easily shoot up irrespective of overall volume. The converse is also true in a down market. So the next time someone tells you that volume matters- they clearly have not done their homework or simply do not know what they are talking about. I’m sure this will stir the pot and I welcome someone to prove me wrong.