Volume is the number of shares of stock, bonds, options, or futures con tracts traded over a designated period (e.g., daily, weekly, monthly). Volume reflects the intensity (strength) of a stock, commodity or index. Volume also provides an indication of the quality of a price trend and the liquidity of a security or commodity.

What volume reveals about the market’s strength

  • High volume means greater reliance can be placed on the movement in price than if there was low volume, because heavy volume is the relative consensus of a large number of participants.
  • High volume indicates an active market; in an active market, the spread between bid and asked prices is usually narrower.
  • High volume is often characteristic of the initial stage in a new trend, such as a breakout in a trading range.  Before a market bottom, investor nervousness leads to panic selling, a characteristic of which is high volume.
  • Low volume often exists during an unsettled period, such as at a market bottom.  Low volume reflects a lack of confidence that is usually indicative of a consolidation period when prices are within a sideways trading range.
  • A sizable increase in volume may point to a breakout (start) or climax (culmination) of a move, which may be temporary or final.  In a rare case, it may represent a shakeout.

Average trading volume typically decreases when a stock is in a downtrend, because investors view negatively a stock declining in price.  An increasing price is typically coupled with increased volume, but the price can decrease without an increase in volume if investors lose interest in the issue.  On the other hand, a declining stock price may be coupled with higher volume when, for example, negative news comes out about the company.

Above table provides general rules for volume analysis. Volume is relative in that it usually is greater approaching the top of a bull market than near the bottom of a bear market. Further, trading volume typically increases and continues higher than average in an uptrend, but is below average during a downtrend. Volume is an indicator of a trend reversal if it goes in a direction contrary to a prevailing trend.

Increasing price and decreasing volume show lack of interest, and this is a warning of a potential reversal. Simple fact is that a price drop (or rise) on little volume is not a strong signal. A price drop (or rise) on large volume is a stronger signal that something in the stock has fundamentally changed. Volume can be very useful in identifying bullish signs. For example, imagine volume increases on a price decline and then the price moves higher, followed by a move back lower. If the price on the move back lower stays higher than the previous low and volume is diminished on the second decline, then this is usually interpreted as a bullish sign.

The following guidelines apply to the study of volume:

  • The market is bullish if a new high occurs with heavy volume. A new high on light volume is deemed temporary.
  • A new low price with high volume is a bearish indicator. A new low on light volume is less significant.
  • If prices advance after a long decline and then go to a level at or above the previous trough, the indicator is bullish when volume on the secondary trough is less than the first.
  • If the market has been increasing for a while, an anemic price increase coupled with high volume is a bearish sign. After a decline, substantial volume with minor price changes points to accumulation, typically a bullish indicator.