Volume is an important factor in technical analysis and can be used to confirm trends and patterns. By looking at volume, it’s possible to get insight into how other investors view the market.
Volume is an indication of the number of shares traded over a certain duration. Activity in a stock is typically correlated to its volume; the higher it is, the busier it has been.
To illustrate, say you and I both buy or sell 100 shares of GNA Axles at 485 – this would result in a trade, but the actual volume created would be 100, not 200, as many would mistakenly assume (100 buys / sells).
This fictional example should aid comprehension of how total trading volume is calculated in a single day:
At 9:30 AM, 400 shares changed hands at 62.20, and an hour later, another 500 exchanges were made at 62.75. By 10:30 AM if you’d checked the day’s volume, it would have totalled 900 (400 + 500). Additionally, 350 shares were traded at 63.10 by 11:30 AM, thus increasing the volume to 1,250 (400 + 500 + 350).
This screenshot, showing the volumes of some shares, was taken at 2:55 PM on 5th of August 2014 from the live market.
At the time of 2:55 PM, a combined 12,72,737 shares of Cummins had been sold at differing price points ranging between 634.90 and 689.85.
With just 35 minutes before markets close, it is likely that volumes will increase if traders keep trading. The following screenshot taken at 3:30 PM shows the same stocks with volume clearly visible.
The volume trend table
The volume of Cummins India is 13,49,736 shares, but this detail only has value when paired with the preceding price and volume trends. Individually it has no relevance or merit. When laid out in the context of a broader pattern, however, it gains significance.
The first line of the table above implies that when both the price and volume increase, it is likely to be indicative of a bullish outlook.
Before we take a closer look at the table, ponder this – what does an ‘increase in volume’ mean? What is being used as a point of comparison? Is the reference point for calculation based on the preceding day’s quantity or over a period of several days?
Traders often compare current volume with the average of their last 10 days. It is usually recommended to follow this rule:
High Volume = Today’s volume > last 10 days average volume
Low Volume = Today’s volume < last 10 days average volume
Average Volume = Today’s volume = last 10 days average volume
To get the last 10-day average, draw a moving average line on the volume bars, and you’re good to go. We will discuss this in detail in the upcoming chapters.
In the chart above, you can observe blue bars at the bottom, which indicate volume. The red line plotted on top indicates the 10-day average. Any volume bars that exceed this average point to increased participation are likely from institutional investors.
Given the information we have, it might be wise to examine the volume-price table.
The thought process behind the volume trend table
It’s no surprise that when institutional investors buy or sell large amounts of shares, it’s a much more significant move than what individual retail traders do.
An example would be India’s LIC; they being one of the country’s biggest domestic institutional investors. If they were to invest in Cummins India, it wouldn’t just be 500 shares, but probably around 500,000 or more. The open market will definitely feel the impact with so many shares being traded at once, and coupled with such huge investment, the share price will start to rise as well.
Therefore rightfully so, we refer to such big investments from large institutions as ‘smart money.’ It is perceived that ‘smart money’ always makes smarter moves in the market than retail traders. Therefore, following smart money is a smart idea
It is clear that a major investor has expressed interest in the stock, with both the price and volume increasing. They are making a smart choice, thus implying an outlook of optimism and creating an opportunity to invest.
When it comes to making purchases, it’s wise to go with the smart money and make sure the quantity is substantial.
The first row of the volume trend table shows that as both price and volume increase, expectations become more optimistic.
What do you believe occurs when the cost increases while the quantity decreases, according to the second row?
The third row argues that a dip in price coupled with an upswing in volume anticipates a bearish outlook. Why might this be the case?
A dip in the price and a surge in trading volumes points to smart money selling the stock. Considering smart money usually makes sound investments, this could be seen as a sign that the stock should be sold and bearish expectations are warranted.
When deciding to sell, make sure you’re in line with the smart money and selling a good amount.
What happens when volume and cost drop, as indicated in the 4th row?
Contemplate it in this way: