Stocks volume is an often ignored metric in a stocks performance. You might say aren’t we only concerned with the price of a stock and its movement? Yes our final concern is price but we want to find indicators of how a price is going to change before it does. Volume is such an indicator. A stock’s trading volume is the amount of stock traded or changed hands during the specified period of time. Generally we refer to daily or weekly trading volume. Now the price of a stock is just like the price of anything else we pay money for in that its value is determined by supply and demand. This is how volume gives us indicators of coming price changes, it tells us the levels of supply or demand for a particular stock. Read on and I will explain exactly how that happens
Stocks and Supply and Demand
Highly successful investor William J. O’Neil noted that “stocks never go up in price by accident – their must be a large buying demand. When demand for something increases and supply remains constant the price increases. Conversely when the supply of something increases and the demand remains constant its price decreases. This is the law of supply and demand and it is a fundamental economic concept. A stock since it is paid for in cash in a free market functions according to this law. When there are more buyers than sellers demand increases and the price eventually increases as well. When there are more sellers than buyers the supply increases and the price eventually decreases. This is just like the housing market. When less are buying houses for whatever reason the cost of houses goes down. What we are going to do is find ways of using the trading volume of a stock to measure its supply and demand levels. Let’s talk about how we can do that.
Evaluating Supply and Demand
The first thing to look for is whether a stock has more buyers or sellers. IN investing terms if a stock has more buyers we say it is being accumulated and if it has more sellers we say is being distributed. To measure whether a stock is being accumulated or distributed we look at the daily trading volume closing price. If the stock closes at a higher price than the previous day on larger volume it’s a signal of accumulation. If it closes at a lower price on higher volume it’s a sign of distribution. With both directions the greater the volume more significant the action is. This is why low volume selling doesn’t necessarily mean you need to sell a because it is being distributed. However if you have multiple days for closing down in price on above average volume you stock may be getting ready to turn or already has.
A rough gauge of accumulation and distribution can be arrived at by looking at a daily stock chart for the stock in question. Count the days where the stock closes up in price on above average trading volume and compare that to the number of days it closes down in price on above average trading volume. This gives you a general indication of whether it is being accumulated or distributed. If you subscribe to a financial paper you may have access to more detailed metrics for accumulation and distribution. Investors Business Daily has an accumulation/distribution rating does a similar count but in much greater detail and it gives A to D scale telling you to what degree a stock is being accumulated or distributed. This can be a big time saver in determining a stocks supply and demand.
Strength of a Breakout
Stock breakouts do not always succeed and instead of blasting to new highs they can’t seem to make it past a point and drop back down. This may happen over the course of one day or it may take multiple days. You can judge the quality of the breakout based on the volume level on the day or days in breaks out. If a stock breaks out on 50% or more above average volume your its likely a breakout that will succeed. Conversely if it’s significantly below average the stock may bounce back after a few days. What is happening is there is a fast increases in demand and a shortage of sellers. Keep in mind that when buying off of a breakout you want to buy when the stock is emerging from a properly formed chart base or area of price consolidation.