Volume And Trading, Not To Be Discounted

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The Most Forgotten Indicator

Volume And Trading, Not To Be Discounted

Volume is a subject that most traders, especially new ones, fail to recognize. It is a very important factor in market movement and a key element of many if not most technical indicators. The volume, the number of shares, lots or tics traded in one day, session, week or month, is the number one way of identifying how much interest there is in an asset. The more volume the more interest and vice versa. Volume can be used in a number of ways but perhaps the most useful is a tool of confirmation. A break above resistance on high volume has more chance of succeeding than one on light volume. Likewise, a long legged doji that appears in conjunction with high volume is more likely to be a turning point in the market than one that appears on low volume. Volume is also useful for forecasting the markets. In a previous post I talked about seasonality in the marketplace and how that can affect volume. If you know that an upcoming season is likely to have more or less than volume you can adjust your strategy to suit.

The most basic form of volume indicator is simple volume. Simple volume is a histogram that appears at the bottom or below most charts and is nothing more than a count of how many shares, lots or tics were traded for the chosen settings. This can range from minute to minute all the way up to monthly data with most charting packages, the ones that count anyway. The caveat here is to know what you are trading and how volume is counted for that asset. Things like stocks, ETF’s and other securities are sold in physical form albeit electronically so it is possible to count actual volume. When you use the volume indicator for stocks like Amazon, Facebook and JP Morgan it is counting the actual number of shares traded for that day. Depending on which package you are using and how you have it set up volume could be the number of shares traded during the open session or include shares traded in the pre and after market sessions. Some assets such as commodities and futures are traded in lots so when assessing a chart of these prices volume is counted in this way. Lots can range from things like one hundred ounces of gold to bushels of corn, barrels of oil or bales of cotton. Now, in terms of things like forex which are traded around the clock in a wide number of forms there is usually not an actual volume that can be tracked. Some platforms do not provide any data for these assets while others may count it on a tick basis whereas each tick represents a trade and is counted as such. This can be useful but not as reliable as actual volume.

Volume has a big impact on market direction.

How To Use Volume As An Indicator

Trading volume can be used as an indicator and trigger for trading. The most commonly used methods are to look for spikes in volume and increases in volume over time. A spike in volume is simply a day in which volume is noticeably higher than in previous days. This is caused by a wide variety of factors but signal a day in which traders were actively buying and selling the asset. If the candle or bar formed is a bearish one then you can say that a high volume of sellers outnumbered a low number of buyers and pushed prices lower. The same is true in reverse, a green or white candle signals that a high number of buyers pushed prices up. Typically traders will track a 30 day moving average of volume and use that as a filter for trading. Only spikes that are 2, 3 or X times the 30 day moving average of volume are counted. This kind of information is readily available on most websites that keep data and information on the stock market such as CNBC.com, YahooFinance and MSN Money if your own platform or broker does not have it. This same method can be used in a longer term framework as well. If average daily volume was X for the last week and then slowly moves up to 1.5X and then 2X over time you can be sure that more interest is building in the asset and apply that knowledge to your trading decisions.

Some Thoughts On Volume

I am a fan of volume and other studies that take volume into account. Price action can give you a decent signal but if the market is not behind it then it has a lot less chance of succeeding Using volume is a great way to help determine the good moves from the bad. Even more important than the volume that occurs on a signal day is the volume that happens on the next day and the next. If high volume continues then you can be assured the move will continue. The caveat is that not all assets or even platforms count volume in the same way so it is important to understand what you are looking at. Further, volume, like all indicators, is not infallible. You have to use it alongside other indicators in order to make the best of it. Additionally, there are plenty of great tools that use volume as the basis of their study such as Volume Flow Indicator to use as well.

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Volume Discount

What Is a Volume Discount?

A volume discount is an economic incentive to encourage individuals or businesses to purchase goods in multiple units or in large quantities. The seller or manufacturer rewards those buying in bulk by providing a reduced price for each good or group of goods. Volume discounts allow businesses to purchase additional inventory at reduced cost and allow sellers or manufacturers to reduce inventories by selling more units to bulk buyers who are incentivized by the lower price.

Key Takeaways

  • A volume discount is a price reduction offered to buyers who purchase in bulk quantities.
  • Producers or sellers are able to reduce inventories and take advantage of economies of scale by allowing discounts to bulk buyers.
  • Several methods exist for arranging volume discounts, often utilizing a tiered discount structure.

Understanding Volume Discounts

Volume discounts allow buyers to purchase goods at a discounted rate. These savings are often passed on to consumers. For example, Walmart is able to purchase such large quantities of each particular good that it routinely receives volume discounts from its vendors. Walmart’s customers, in turn, are able to purchase these goods for less money than if they went to a store that did not buy in such great volume.

In financial markets, some brokerage firms offer volume discounts on commissions charged depending on the level of investment or trading activity or for large block order trades.

How Volume Discounts Work

The discounts can take on a variety of structures. Volume discounts are often tiered—that is, a specific discount is applied to X number of units within that tier. The discount increases as for tiers that include larger and larger numbers of units. For instance, a discount could be applied to 50 to 100 units sold, with a greater discount for 101 to 200 units sold, and an even larger discount could apply to 201 to 300 units sold, and so on.

Another method of offering volume discounts is to apply a lower rate only when a certain threshold is reached. For example, the discount might go into effect after 100 units are purchased, and only apply to the units beyond that threshold. The buyer would still pay full price for the first 100 units they procured.

Yet another discount structure is to offer reduced prices on packages of units. A discount price could be offered for every 10 units sold, with the same rate applied equally. Another deeper discount rate might then be applied for every 25 units sold. In order to reap the benefits of the lower prices, the buyer must purchase units in the stated increments. In the previous example, if the buyer purchased 15 units, they would pay the lower rate only for 10 units and full price for the remaining five units. The same would be true if 27 units were purchased; two units would cost full price while 25 units get the lower rate. The volume discount would not apply to the entire order.

The Top 7 Risks of Trading Low-Volume Stocks

A significant percentage of shares are very thinly traded stocks. These stocks trade irregularly or at low volumes. Investors should be aware of the considerable risks of trading in these low-volume stocks. Below, we deal with seven of the top dangers.

There is no need to invest in low-volume stocks. Most investors are better off with ETFs, mutual funds, and large listed companies.

1. Low Liquidity Makes Trading Difficult

One risk of low-volume stocks is that they lack liquidity, which is a crucial consideration for stock traders. Liquidity is the ability to quickly buy or sell a security in the market without a change in price. That means traders should be able to buy and sell a stock which is trading at $25 per share in large amounts, such as 100,000 shares, while still maintaining the price of $25 per share. Low liquidity can also cause problems for smaller investors because it leads to a high bid-ask spread. The average daily trading volume is a good measure of liquidity. As a general rule, frequent traders often lose money when liquidity is low.

2. Challenges in Profit Taking

Lack of trading volume indicates interest from only a few market participants, who can then command a premium for trading such stocks. Even if one is sitting on unrealized gains on these stocks, it may not be possible to take the profits. Suppose that you purchased 10,000 shares of a company at $10 per share one year ago, and then the price rose to $13. Thus, you are sitting on an unrealized profit of 30%. You would like to sell your 10,000 shares and pocket the gains. If the average daily trading volume of this stock is only 100 shares, it will take time to sell 10,000 at the market price. The act of selling your shares may also affect prices in a low-volume stock. Flooding the market with a large supply of the stock can cause prices to fall considerably if the demand remains at a consistently low level.

3. Manipulative Market Makers

Market makers active in low-volume stocks can use low liquidity to profit. They are aware that the stock’s low liquidity means they can take advantage of buyers who are eager to get in and out of the market. For example, a market maker might place a bid for 100 shares near the last sale price and a bid for 1,000 at 10% below that price. If someone naively attempts to sell 1,000 shares at the market price, then they might only get what they expected for the first 100 and get 10% less for the rest. It is necessary to use limit orders for low-volume stocks if you want to avoid these losses.

4. Deteriorating Company Reputation

Although low trading volumes are observed across stocks belonging to all price segments, they are especially common for microcap companies and penny stocks. Many such companies trade on OTC markets, which don’t require them to give investors as much information as firms listed on major stock exchanges. Often, such companies are new and lack proven track records. Low trading volumes may be an indication of a deteriorating company reputation, which will further affect the stock’s returns. It may also be an indication of a relatively new company that has yet to prove its worth.

5. Uncertainty About the Larger Picture

What are the real underlying reasons behind the low trading volume of the stock? Why is there no interest or a wider audience for trading this stock? What is a reasonable price for this stock? Are prices high because someone bought up many shares recently? Or is it the other way around? Are prices low because a big investor dumped shares on the market? Is the company involved in some irregularities that cause its shares to be too risky for most traders? The lack of transparency and difficulty of price discovery make it challenging to see the larger picture for low-volume stocks.

6. Susceptibility to Promotion

Company promoters are best informed about the realistic valuations of a stock. Low trading volumes often lead to temporary periods of artificially inflated prices. That allows promoters to offload their large shareholdings to common investors. Sometimes, this situation can cross the line from perfectly legal self-promotion to illegal pump-and-dump scams.

7. Vulnerability to Marketing Misconduct

Dishonest brokers and salespeople find such low volume stocks an excellent tool to make cold calls with claims of having the insider information on the next so-called tenbagger. Other practices involve issuing fraudulent press releases to lie about prospects for high returns. Many individual investors can fall prey to such practices.

The Bottom Line

The reality is that low-volume stocks are usually not trading for a very good reason—few people want them. Their lack of liquidity makes them hard to sell even if the stock appreciates. They are also susceptible to price manipulation and attractive to scammers. Traders and investors should exercise caution and perform due diligence before purchasing low-volume stocks.

How to Use Volume to Improve Your Trading

Volume is a measure of how much of a given financial asset has traded in a period of time. For stocks, volume is measured in the number of shares traded and, for futures and options, it is based on how many contracts have changed hands. The numbers, and other indicators that use volume data, are often provided with online charts. Looking at volume patterns over time can help get a sense of the strength or conviction behind advances and declines in specific stocks and entire markets.

Basic Guidelines for Using Volume

When analyzing volume, there are usually guidelines used to determine the strength or weakness of a move. As traders, we are more inclined to join strong moves and take no part in moves that show weakness—or we may even watch for an entry in the opposite direction of a weak move. These guidelines do not hold true in all situations, but they offer general guidance for trading decisions.

Key Takeaways

  • Volume measures the number of shares traded in a stock or contracts traded in futures or options.
  • Volume can be an indicator of market strength, as rising markets on increasing volume are typically viewed as strong and healthy.
  • When prices fall on increasing volume, the trend is gathering strength to the downside.
  • When prices reach new highs (or no lows) on decreasing volume, watch out; a reversal might be taking shape.
  • On Balance Volume and Klinger Indicator are examples of charting tools that are based on volume.

Trend Confirmation

A rising market should see rising volume. Buyers require increasing numbers and increasing enthusiasm in order to keep pushing prices higher. Increasing price and decreasing volume might suggest a lack of interest, and this is a warning of a potential reversal. This can be hard to wrap your mind around, but the simple fact is that a price drop (or rise) on little volume is not a strong signal. A price drop (or rise) on large volume is a stronger signal that something in the stock has fundamentally changed.

Exhaustion Moves and Volume

In a rising or falling market, we can see exhaustion moves. These are generally sharp moves in price combined with a sharp increase in volume, which signals the potential end of a trend. Participants who waited and are afraid of missing more of the move pile in at market tops, exhausting the number of buyers.

At a market bottom, falling prices eventually force out large numbers of traders, resulting in volatility and increased volume. We will see a decrease in volume after the spike in these situations, but how volume continues to play out over the next days, weeks, and months can be analyzed using the other volume guidelines.

Bullish Signs

Volume can be useful in identifying bullish signs. For example, imagine volume increases on a price decline and then the price moves higher, followed by a move back lower. If the price on the move back lower doesn’t fall below the previous low, and volume is diminished on the second decline, then this is usually interpreted as a bullish sign.

Volume and Price Reversals

After a long price move higher or lower, if the price begins to range with little price movement and heavy volume, this might indicate that a reversal is underway, and prices will change direction.

Volume and Breakouts vs. False Breakouts

On the initial breakout from a range or other chart pattern, a rise in volume indicates strength in the move. Little change in volume or declining volume on a breakout indicates a lack of interest and a higher probability for a false breakout.

Volume is often viewed as an indicator of liquidity, as stocks or markets with the most volume are the most liquid and considered the best for short-term trading; there are many buyers and sellers ready to trade at various prices.

Volume History

Volume should be looked at relative to recent history. Comparing today to volume 50 years ago might provide irrelevant data. The more recent the data sets, the more relevant they are likely to be.

Volume Indicators

Volume indicators are mathematical formulas that are visually represented in most commonly used charting platforms. Each indicator uses a slightly different formula, and traders should find the indicator that works best for their particular market approach. Indicators are not required, but they can aid in the trading decision process. There are many volume indicators to choose from, and the following provides a sampling of how several of them can be used.

On Balance Volume (OBV): OBV is a simple but effective indicator. Volume is added (starting with an arbitrary number) when the market finishes higher, or volume is subtracted when the market finishes lower. This provides a running total and shows which stocks are being accumulated. It can also show divergences, such as when a price rises, but volume is increasing at a slower rate or even beginning to fall.

Chaikin Money Flow: Rising prices should be accompanied by rising volume, so Chaikin Money Flow focuses on expanding volume when prices finish in the upper or lower portion of their daily range and then provides a value for the corresponding strength. When closing prices are in the upper portion of the day’s range, and volume is expanding, the values will be high; when closing prices are in the lower portion of the range, values will be negative. Chaikin money flow can be used as a short-term indicator because it oscillates, but it is more commonly used for seeing divergence.

Klinger Oscillator: Fluctuation above and below the zero line can be used to aid other trading signals. The Klinger oscillator sums the accumulation (buying) and distribution (selling) volumes for a given time period.

A Simple Way to Read Intraday Volume

Intraday equity volume can be tough to read because market participation is skewed toward the beginning and end of the trading day, with volume shrinking through the lunch hour and picking up in the late afternoon. What looks like a high volume event at the start of the session can fizzle out, trapping short-term traders who use this technical data to trigger buy and sell signals.

It’s estimated that 70-75% of all volume is booked in the first and last hours of the trading day. The first hour shows heavy participation because it captures overnight sentiment and news flow as well as plays set into motion by individuals and institutions using previous end-of-day analysis. The last hour attracts broad interest because it wraps up intraday themes while drawing in speculative capital looking to benefit from that day’s trade flow.

Several analytical techniques let traders measure intraday participation levels and estimate closing volume, often with surprising accuracy. These methods produce practical data as soon as the end of the first hour, leaving plenty of time to build strategies that capitalize on high emotional levels in play when a security is set to print two, three or four times average daily volume.

Volume Run Rate vs. Average Daily Volume

One of the most effective techniques compares the real-time intraday volume to a pre-selected moving average of volume. Average daily volume often comes preloaded in charting packages, attuned to either a 50- or 60-day simple moving average. It’s an easy calculation when custom input is required, taking the chosen period and dividing by the sum of volume booked during that period.

For example: Volume (Day 1 + Day 2 + … + Day 50)/50= 50-Day Average Volume

Technicians can apply a more precise exponential moving average instead of a simple moving average, but it isn’t required because the output is used to build a broad estimate of participation rather than an exact numerical level. It’s also more art than science because average volume shifts naturally over a trading year, with higher participation levels in the first and fourth quarters.

Using the Quote Sheet Method

There are two ways to compare average daily volume to intraday volume: one visual and the other analytical. First, place average volume next to real-time volume on a quote sheet, using the proximity to compare dozens of securities at the same time. Second, build a running total of average daily volume and superimpose it over volume histograms at the bottom of the chart. This second method can also be used for end-of-day analysis, as well as measuring the impact of a rising or falling average over time.

When using the quote sheet method, wait until the end of the first hour and then look for securities that have already traded more than one-third of the average daily volume. This cutoff figure utilizes the 70-75% skewing, assuming that roughly one-third of that session’s volume will be booked in the first hour, another third into the last hour and the final third into the closing bell.

Re-check the numbers at the end of the second hour to see if the run rate tracks your initial observations. This is important because overnight themes may not be fully discounted, extending high participation levels. This is especially true when U.S. equity markets trade in lockstep with European bourses that close at the New York lunch hour. When the run rate continues to exceed average daily volume into midday, assume it will do so for the rest of the session, supporting volume-based trading signals.

The Bottom Line

Measure the flow of intraday volume to estimate the emotional intensity of the crowd, looking for greater than average participation to yield profitable trading opportunities.

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