Should You Pay Attention to a Stock’s Trading Volume?

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Investors monitor stock volumes closely to confirm market trends and make informed decisions about which stocks to buy or sell within their portfolios. Trade volume, essentially the number of shares traded over a given period of time, can provide key insights into market interest and momentum. For example, a high trading volume may indicate strong interest and liquidity, signaling an opportune moment to buy if you’re looking to enter a rising market. Conversely, a sudden drop in volume might suggest diminished interest, which could be a cue to sell and preserve gains or limit losses. Trade volume can help investors better time their entry and exit points, optimizing portfolio strategy.

A financial advisor can help you create a financial plan for your investment needs and goals.

What Is Trading Volume?

Trading volume is a way to measure how often a security trades over a set period of time. Traders often measure volume on a daily basis. But they also measure trading volume over shorter or longer time frames. For example, you might analyze trading volume over the previous 30 days or year to date.

There are two sides to trading volume transactions: the buy side and the sell side. Say you sell 500 shares of XYZ stock. If another investor buys them, the total trading volume is 500 shares, not 1,000. Volume has a correlation to a stock’s price: Trading activity can fluctuate as share prices increase or decrease.

For example, trading volume may pick up if political or economic fears trigger a sell-off. On the other hand, if volume increases along with prices, then that may signal a strong market.

High Volume Stocks and Low Volume Stocks

Stocks can be categorized as high volume stocks or low volume stocks, based on their trading activity. High volume stocks trade more often. Meanwhile, low volume stocks are more thinly traded. There’s no specific dividing line between the two. However, high volume stocks typically trade at a volume of 500,000 or more shares per day. Low volume stocks would be below that mark.

Pros and Cons of High Volume Stocks

• Minimize volatility. By nature, a stock that’s trading at a higher volume may be less volatile. This means you’re less likely to see huge swings in pricing over the course of a trading day. That can lower your risk factor since larger numbers of investors pour money into the stocks.
• Narrow spreads. High volume stocks tend to have a much closer gap between the bid price and ask price. A buyer prepares to pay a bid price, while the seller sets an ask price. Smaller spreads can translate to more buying and selling opportunities for investors.
• Reduced liquidity risk.Liquidity measures how easily you can convert your investments to cash. There tend to be more investors trading high volume stocks. As a result, they reduce your risk of not being able to liquidate assets.
• Can require more speculation. High volume stocks might be fairly obscure. For example, you may invest in penny stocks trading at high numbers. Penny stocks could offer an opportunity if they take off. However, you may take on more risk with an unproven company.

Pros and Cons of Low Volume Stocks

• More opportunity. Stocks that trade at low volumes may offer more opportunities for investors. Such stocks simply create less demand. Value investors, for example, may capitalize on undervalued stocks. Those stocks may increase in value over the long-term. Growth investors could similarly find an opportunity to purchase an inexpensive stock that’s on its way up.
• Potential for increased volatility. Lower trading volume can make stock share prices more sensitive to volatility. In other words, you’re more likely to see substantial price swings with a stock that’s traded less frequently versus one that’s regularly trading hundreds of thousands of shares per day.
• Reduced liquidity. Since there are fewer shares traded, investors may find it more challenging to find a buyer when they need to sell to liquidate assets. You might have seen some big gains in price with a stock that’s trading at a lower volume but unless you have someone who’s ready to buy all of your shares in one go, it may take you longer to sell them and reap the rewards.

Is Trading Volume a Useful Indicator?

There are a few ways that trading volume can help with evaluating stocks and broader market trends as a whole.

For example, tracking volume can help you get a sense of where the market is going collectively. If the volume is on the increase overall, you can go deeper to analyze what’s driving higher trading activity. Specifically, you’d want to look at how prices are moving in connection with trading volume. When prices move up or down sharply on increasing or decreasing volume, that can signal that a shift is happening or is about to happen in the market.

That, in turn, can help with determining when to buy or sell. For example, in a market environment where prices are falling and volume is increasing, you may decide to buy in to try and profit when the market recovers and prices start rising again. Or you could decide to sell off some of your stocks to minimize losses.

Trading volume can also send signals about whether the market is trending bullish or bearish, or whether a particular stock is likely to have a breakout movement. Breakouts happen when a stock’s price moves above a certain level. If the higher price holds, a breakout may follow. Trading volume can also help you pinpoint potentially false breakouts when a stock is signaling that it’s share price is about to increase but it actually isn’t.

Bottom Line

Trading volume is just one way to evaluate stocks when deciding whether to buy or sell. This technical indicator may be more helpful for decision-making with day trading strategies, versus evaluating stocks or mutual funds to invest in for the long-term. If you’re using this metric to compare stocks, remember to consider the bigger picture in terms of historical performance and other factors that could be impacting the markets.

Investing Tips

• Consider talking with your financial advisor about using trading volume as a yardstick for measuring stocks. If you don’t have an advisor yet, finding one doesn’t have to be difficult. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
• It’s helpful to familiarize yourself with different investment analysis strategies when building a portfolio. Technical analysis, for example, relies on pricing trends and trading movements while fundamental analysis looks more closely at a company’s fundamentals. Understanding how the two compare can help you determine which approach better fits your investment style.

Photo credit: ©iStock.com/SARINYAPINNGAM, ©iStock.com/Maximusnd, ©iStock.com/Drazen Zigic

Rebecca Lake, CEPF®Rebecca Lake is a retirement, investing and estate planning expert who has been writing about personal finance for a decade. Her expertise in the finance niche also extends to home buying, credit cards, banking and small business. She’s worked directly with several major financial and insurance brands, including Citibank, Discover and AIG and her writing has appeared online at U.S. News and World Report, CreditCards.com and Investopedia. Rebecca is a graduate of the University of South Carolina and she also attended Charleston Southern University as a graduate student. Originally from central Virginia, she now lives on the North Carolina coast along with her two children. Rebecca also holds the Certified Educator in Personal Finance (CEPF®) designation.

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