The volume is reported as the number of shares that changed hands during a certain period. The theory behind analyzing volume is that if the stock is trading above the normal volume it usually trades at, it signals a potential price movement soon.
Here’s an example of Google stocks price movement between August to November 2019.
The color of the bar chart indicates if the price closed above the opening price or below the opening price. A price that closed above the opening price is usually highlighted in green, and vice versa in red.
Volume analysis is viewed as an important tool by many traders because it reflects not just the opinions but the real actions of traders in the marketplace.
Indicators: Spikes in Volume
One key indicator to look for is a significant volume increase or decreases in a certain direction. Take the same example above. At the end of July, Google’s earning report came out and was higher than expected.
The surprise caused a huge demand for Google stocks, leading to a significant amount of buy orders in a short amount of time. The stock increased by 10% in a short amount of time.
The volume spike here can indicate whether the stock was overbought or oversold. In this example, the Google stock was overbought and correction happened shortly after. Within the next week, Google stocks dropped back 8%.
In this example, you could have taken a short position expecting the price to correct, gaining you 8% within a week.
Indicators: Trend Confirmation
Another use for volume analysis is to determine momentum. The theory is that as volume increases, price generally continue the same trend. For example, if the price is on a bullish trend and volume has been steadily increasing, its predicted that the price will continue to increase.
The opposite applies where if the price has been on a bearish trend and volume continues to increase, it’s likely the price will continue to decrease.
See below for a live example of Apple stocks in October:
- Volume is low and it is uncertain whether price will increase or decrease
- Volume begins to rise as price increases, signally that the price will continue to rise
- Volume is low again and it is uncertain whether price will increase or decrease
- Volume begins to rise as price decrease, signally that the price will continue to decrease