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Why Is Trading Volume Important to Investors?

There are plenty of things to keep in mind when investing in stocks. You want to do your research before you get involved to ensure you make the most of your investments. One of the key concepts to understand is trading volume.
What is it and why does it matter to investors?

Trading volume in a nutshell

Trading volume is sometimes just referred to as volume and it shows the number of shares or contracts, which indicate the overall activity of a security or a market. It’s a technical indicator of what the current trends are – is something a trend or a reversal of trend. By examining the trading volume, an investor is able to get an idea of the price action of a security. The information will then help make the decision of whether to buy or sell the stock.

If you look at the information by the major stock exchanges around the world, they will report the trading volume figures every day. This is usually the case for both the individual issues trading and the total amount of trading on the exchange. You can, therefore, use the information to understand the market liquidity and the supply and demand for securities.

Now, while the information is generally publicly available it is also possible to calculate it yourself. You simply need to look at the day’s transactions – which are publicly available – and see the total amount of shares traded.

Why is trading volume important to investors?

So, why does all of that matter to investors? Trading volume is important because it is an indicator of what is happening in the market – it shows you the trends in terms of trading and the price.

Let’s look at pricing momentum. When the stock market activity, which is the trading volume essentially, is low, the investor anticipation is often on slowing prices. Furthermore, it can be an indication of declining prices. When the activity or trading volume is high, then pricing is moving fast and often increasing.

Interestingly, a low volume can even indicate a lack of conviction amongst investors, even if the price is rising. On the other hand, when the volume is high – even with lower prices – investors are essentially indicating a long-term commitment on the stock.

Now, examining these volumes can help investors understand the trends and indicate a future behaviour. Indeed, some investors use trading volume as a warning sigh to potential problems.

If there’s a dramatic increase in trading volume, it generally means a future sharp rise or a drop in price. However, when volume remains low, the pricing can be more volatile and often less trustworthy of the stock’s real value.

So, to recap: in terms of market interest, if the volume is rising than the market price should be rising. If there is an increasing price but decreasing volume then the market is showing a lack of interest and a potential danger. On the other hand, if the volume is low and the price drops, the stock is not experiencing much difference. A price drop or, indeed, rise on a large volume is always a stronger indicator of a fundamental change in the market.

By examining the trading volume, you will be able to see whether the market is strong or weak for the particular investment. You can also confirm the price and identify the trends behind any pricing changes. This makes it a great indicator to help in your decision-making process.

Trading volume can be used as an analytical tool. It doesn’t always tell you the full story on its own but it can certainly point you in the right direction – it’s an indicator of trends in the market.

Getting started with investing

If you are serious about investing, it’s important to get to grips with concepts like the above. You want to know the investment world inside out because it ensures you make the right decisions – knowledge is power in the investment world.

You can find plenty of information online. Check out the blogs at CompleteMarkets and don’t be afraid to read a few good investment books. The Intelligent Investor: The Definitive Book on Value Investing by Benjamin Graham and Stocks for the Long Run: The Definitive Guide to Financial Market Returns & Long-Run Investment Strategies by Jeremy Siegel is worth reading and you can find them at Booktopia. For the books and trading software, head down to OZCodes online coupon portal. You can find saving codes there to start your investment journey while saving money.

So, hopefully, you can take away the key lesson from the above post: trading volume is an important indicator of stock market trends. It’s not the only thing that matters, but it can be a helpful part of analysing what is currently happening with a specific stock. Now you just need to get started and turn your investments into riches.

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Lena Burkut
Other articles by: Lena Burkut
Categories: Finance
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