Volume Analysis in Day Trading

Use volume trends to improve your results

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In trading, the term volume represents the number of units that change hands for stocks or futures contracts over a specific time period. Traders rely on it as a key metric because it lets them know the liquidity level of an asset, and how easily they can get into or out of a position close to the current price, which can be a moving target.

Volume analysis is a technique used to determine the trades you will make by discovering the relationships between volume and prices. The two key concepts behind volume analysis are buying volume and selling volume.

Buying Volume

When trading volume is higher, you'll have an easier time buying and selling large or small quantities of stock, because other traders are in the market, waiting to fulfill the other side of your trade.

Each transaction must have a buyer and a seller. To buy a stock, for example, a seller must sell to you, and for you to sell, a buyer must buy from you.

This leads to some confusion because you'll often hear phrases like:

  • The sellers are in control
  • Buying volume is outstripping selling volume
  • It's a heavy buy volume day

Buyers have control when the price gets pushed higher. Buy volume occurs at the offer price, and represents the lowest advertised price at which sellers will part with their shares. When someone buys shares at the current offer price, it shows that someone desires the stock and is included in the buying volume metric.

Selling Volume

Sellers have more control when the price gets pushed lower. Sell volume occurs at the bid price. The bid represents the highest advertised price buyers will offer. If someone wants to sell at the bid price, it shows that the seller doesn't desire the stock (this demonstrates an example of selling volume).

Volume typically shows along the bottom of a stock price chart. Charts depict trading volume in vertical bars, with the bar showing how many shares changed hands over a particular time period.

The image below is a trading example of a 1-minute chart, where each volume bar along the bottom shows how many shares were traded in each one minute period. The volume bars on a daily chart show how many shares change hands during the course of each day.

buying and selling volume on a 1-minute chart
FreeStockCharts.com

Volume bars may be colored. A red volume bar means the price declined during that period and the market considers the volume during that period as selling volume (estimated). If the volume has a green bar, then the price rose during that period and it is considered by the market as buying volume (estimated).

Relative Volume

Traders prefer day trading stock with volume as it allows you to get into and out of a position quickly, with large or small positions.

The average volume statistic shows how many shares change hands in investments on a normal day. Some days will have a much higher volume than normal, while other days see a lower volume.

Day traders tend to gravitate toward stocks or exchange-traded funds (ETFs) with a high average volume, and/or stocks or ETFs that have had a higher-than-usual volume on a particular day. Lower-than-average volume shows lower interest in the stock on that day and likely smaller price movements.

Higher Volume

Pay attention to days that have higher-than-usual volume. Such days usually have volatility and large price moves either up or down. If most of the volume takes place at the bid price, then the price will move lower and the increased volume shows that sellers are motivated to get rid of the stock.

If most of the volume has taken place at the ask price, then the stock price will move higher (due to demand and price availability). The increased volume shows buyers believe the stock is moving, and want to purchase the stock.

Increased volume typically shows that something has happened with the stock. Typically, a news release or active traders that have become worried or euphoric about the stock's potential suddenly influence volume trading.

Analyzing Stock Price Movements

While not necessary, monitoring a stock's trading volume can aid in analyzing stock price movements. You may find the following guidelines and descriptions helpful for understanding and analyzing volume.

An increasing volume shows the conviction of buyers and sellers in either pushing the price up or down, respectively. For example, if the stock trend heads up and volume increases as the price moves higher, it shows buyers have an eagerness to buy; this typically happens with larger moves to the upside (positive returns).

A trend can persist on declining volume for long periods of time, but typically declining volume as the price trends indicates the trend is weakening. For example, if the trend heads up but volume steadily declines, it shows fewer people want to buy and keep pushing the price up. That said, the trend won't change until more large-scale selling volume than buying volume takes place.

Pullbacks

Volume should ideally be larger when the price moves in the trending direction, and lower when moving against the trend, called pullbacks. This shows strong movement in the trend direction and weak pullbacks, making the trend more likely to continue.

High volume accompanied by sharp price movements against the trend signifies the trend is weakening, and/or is susceptible to a reversal.

An extreme volume spike is where volume trends up more than normal (five to 10 times or more than average volume) for that time or period could indicate the end of a trend. These are termed exhaustion moves—when enough shares change hands that no one remains to keep pushing the price in the trending direction, it will often quickly reverse.

The Final Word

Volume can offer useful information when day trading. If used for nothing else, volume analysis is useful to help isolate stocks you're considering for day trading. Ideally, your day trading stocks should have more average volume so you can enter and exit easily.

This helps control risk as you can reduce losses where you want with minimal price slippage. It also makes collecting your profits easier because many other traders will want to take your position (buy from you when you sell) when you are satisfied with your profits.

Volume can also be used to analyze the trend of a stock, helping to assess the likelihood that a trend will continue. Volume analysis isn't perfect and it offers only supplemental information, so you don't need to feel pressured to start analyzing volume to day trade successfully.

Trading decisions should be based on price movements first and foremost, as price movements determine profits and losses. Formulate your stock day trading strategy based on price movements, and then add in volume analysis to see if it improves your performance.