In the stock market, there are various forces working behind the movement of stocks during trading hours. Volume is one of the important factors responsible for stock prices moving in the upward or downward direction during a specific period.
Volume in trading shows there are too many buyers and sellers taking interest in the stock and they are making the trade positions into the stock or underlying security as per their perception towards the stock and its trend. Today here,in this article we will discuss about the importance of volume in technical analysis and its use or role in trading.
What is the Volume in Stock Market?
In the stock market, traders measure volume by counting the number of shares or contracts traded within a specific period, typically one day. The higher the volume, it means the trading in stock is highly active and there would be either side movement.
Volume is also shown along with the chart bars and can be visible at the bottom of the charts. And volume illustrates how much quantity of shares have been traded on a particular day and it shows the trend of stock where is being headed.
What is the Use of Volume in Trading?
In trading, volume is used to find out the liquidity in a particular stock. Traders check the average daily, weekly or monthly volume in trading to know whether stocks have sufficient buyers and sellers or not, and then decide what to do.
Mainly, intraday traders always consider the volume before making any long or short position in the stock market, because without volume there would be no movement in the stock and maybe it will not move as per your expectations.
Many times intraday traders pick the stock as per the momentum and that is possible when there will be enough volume in that stock. Volume in trading is important not only in stocks but in the derivatives market or F&O segment, without substantial volume traders do not take any position, as their trade will become ideal due to lack of volume in trading.
Importance of Volume in Trading
With the time being and listing of more shares in the stock market, volume is becoming the key factor, without volume you will not have multiple buyers and sellers of any stock in the market. Volume plays a game-changing role in trading.
Moreover, when there is movement in any stock or it comes out from its range-bound trend, volume plays an important role. A breakout and breakdown in stocks happen when volume surges more daily average and one side traders either buyers or sellers become dominant resulting they push that stock from its trading range and moving into a new direction.
What is Volume in Technical Analysis?
Traders use technical analysis to decide between buying and selling stocks. It helps them to know whether a stock is likely to move in which direction and also decide the entry and exit points. And volume plays an important role in technical analysis while making such crucial decisions of buying and selling the stocks at the best levels.
In technical analysis, various tools and techniques like examining the formation of candlestick charts, RSI, Moving Averages, Bollinger Band, and Fibonacci Retracement are used to analyze the stocks technically.
And without significant volume, all these tools and techniques are useless, as they will not be effective and stock price prediction based on these tools without sufficient volume would be not reliable. Stock Breakout & Breakdown is another technique in technical analysis that happens when there is a huge volume in trading.
To check the volume, bar charts are analyzed, if these bar charts are higher than average, it means there is strength in the market price of the stock. Here analysts use the bar chart to analyse the volume to make sure the price movement is strong.
In technical analysis, support and resistance are the strong point to enter or exit in any stock. And when there is an increase in the volume at these points, the stock breaks the support or resistance and traders make trading positions in such stocks.
How to Use Volume in Technical Analysis?
Using the volume of trade in technical analysis, you must have the knowledge and experience of correlating the tools and techniques that are effective when there is volume in trade. In technical analysis, volume is not the prime factor but without volume, the trend reversal or breakout and breakdown in stock can be false.
Hence, apart from all the methods that indicate the price movement of stock, volume is another important factor that needs to be considered while buying or selling stocks. Let’s find out below how volume can be used in technical analysis.
Using Volume with Moving Averages: Moving Averages are another important technical indicator used by traders in technical analysis. The moving average is the average price stock over a specific period like 20 days, 50 days or 200 days. Traders compare the volume with moving averages to determine whether the stock price movement is supported by volume or not.
Moving average and Volume increase
Here, if the stock price moves above the moving average and volume increase, it means that the trend is likely to continue further. While on the other hand, if the stock price moves below the moving average and volume decrease, it means the trend is likely to reverse. Comparing the volume with Moving Averages traders make the positions.
Volume Analysis with Divergence: The divergence in the volume of trade when the price of security moves in a single direction while volume is moving in the opposite direction. Let’s make it clear with an example – suppose the price of stock increases but the volume is decreasing, it indicates that the price increase is not sustainable and the price correction is pending.
While on the other hand, analyzing volume with divergence,if the price of the stock decreases, but volume is increasing, it indicates that the price decline is substantial and a trend reversal might be taking place shortly.
Check the Spikes in Volume: The spikes in volume happen, when the volume of stock rapidly increases or decreases. And these spikes can be triggered due to important corporate actions, worthy news events and major collaborations, mergers or demerger announcements by the company. You can analyze the volume spikes to determine whether such actions are likely to have a significant impact on the price of the stock.
Importance of Volume in Technical Analysis
Volume is playing a vital role in technical analysis by using the combination of tools and techniques authenticated with volume in trade. It helps to make sure the trend and chart patterns are going to give the right predictions.
Any kind of stock price movement upward side or downward side with relatively high volume is perceived as a solid and more relevant move compared to a similar move with weak volume. Traders always check the volume along with the other technical analysis tools to make sure the trend is likely to continue or reverse shortly.
Volume indicates the level of liquidity in the stock. When a stock has a huge volume, traders consider it highly liquid. In contrast, they view a stock with low volume as not liquid, typically choosing it for short-selling or for taking positions in futures and options trading.
Trading volume in technical analysis is like validating the price movement of stock when there is a breakout, breakdown or trend reversal. And when there is momentum in the stock, the price changes and if trading volume increases, the stock price is likely to move in the same direction.
Role of Volume in Technical Analysis
Volume in technical analysis is playing an important role while buying and selling stocks. From trend confirmation to high liquidity and stock price breakout or breakdown, volume plays a crucial decision while making the right position in the trade.
When the volume of trading surges in any stock, it means there could be a significant in the price of the stock. Let’s find out some of the key role volume plays in technical analysis and trading in the stock market for better returns.
Trend Confirmation:
Rising volume with rise in the price of stock means the market is rising and when buyers keep pushing the price, they show high expectations. An increase in the volume of data also encourages buyers more to buy.
Only rising the price of the stock would be not enough, the significant volume in the same gives a strong signal that investors are optimistic. When price increases, along with a decrease in trading volume, it is a warning to investors interested in the market.
Price Reversals:
Suppose the price of a stock has progressed in a single direction for a long time that could be a positive or negative price movement. If the price change at a low percentage and volume is very, it means it is a signal of a price reversal in future. Such indication means that the price increasing over the previous long time and now the direction is likely to change in this stock.
Liquidity in the Market:
When the volume of trade in the main index is significantly high, it means there is ample liquidity in the market. A market with high trading volumes means liquidity in the market and many buyers and sellers are ready to trade.
Breakouts from the Range bound:
If a stock was trading in a range-bound market and breaks out with the price moving above that range, traders can use volume as a reliable indicator of the breakout’s strength.
Signs of Bullish Market:
Volume plays an important role to identify the bullish signs in the market. Let’s take an example, suppose a stock price declines, while volume increases. As a result, the price will moveup and then fall again.If the price decreases a second time but does not go lower than the first low, the volume during the second decline reduces. Traders consider this a signal of a bullish market trend.
Volume Indicator in Technical Analysis
In fact volume act as one of the leading indicators in technical analysis that helps to understand the trends and patterns. This mainly indicates how much traders are trading stocks in the market at a given period, helping to understand their perception of the market.
However, the main use of the volume is that it indicates the price movement of the stock giving the initial signals when the movement of price is going to continue or reverse. For traders, volume is a very useful indicator, and in technical analysis, there are many ways volume works as a good indicator, let’s find out what are those indicators.
Price-Volume Trend Indicator:
Volume-price indicator indicates the movement of the direction of price along with the strength of change in price. This indicator is like an on-balance volume (OBV) indicator that measures the cumulative volume and also provides information about the money flow in the market.
On-Balance Volume Indicator:
It is another volume indicator, that calculates the pressure of buying and selling in the market as a cumulative indicator that adds the volume on up days and deducts volume on down days.
If the stock moves higher than the previous close, traders consider the entire day’s volume as up-volume. Likewise, when the stock ends lower than the previous close, they consider the entire day’s volume as down-volume.
Accumulation/distribution:
The accumulation distribution line is a volume indicator that measures, the cumulative flow of money into the stock. This helps to detect positive or negative divergences in price and volume data that signals an advanced warning of future price movement of the stock.
Money Flow Index:
This is the kind of movement along with a volume indicator which analyses both price and time of the stock to find out the buying and selling pressure in that stock.Traders also know it as volume-weighted RSI because it accounts for volume, unlike RSI, which only incorporates price.
Ease of Movement:
It is a type of oscillator in technical analysis that measures how traders can move a stock based on average volume trends. The indicator is suitable for stocks that are behaviorally highly volatile in the market allowing the stock traders to forecast trends without worrying about the fluctuations in the market.
A high and positive value for EOM indicates that the stock price is increasing with low volume.While negative value designates price falling at low volume. Hence, you can use EOM, as a secondary indicator along with several other indicators like RSI, Moving Averages and others.
Chaikin Money Flow Indicator:
It is another important volume indicator that helps to measure the amount of money that flows into the market, which means trading in a particular stock. Chaikin Money Flow adds Money Flow Volume for a period of around 20 or 21 days in back days.
And this indicator oscillates above/below the zero line just like an oscillator. As per the indicator if the closing price is near to the high then more accumulation takes place. Similarly, if the closing price is at the lowest then, more distribution takes place.