Volume Analysis

What is Volume Analysis?

Volume analysis refers to the examination of the total number of securities transacted within a given time period. They can be shares or contracts of any given security. Technical analysts consider trading volume as one of the major indicators of the probability of success of a particular trading decision. Investors can arrive at the degree of impact of the changes in the price of a security on the return by analyzing trends associated with volume, as well as price movements.

Volume, simply put, is the number of contracts that exchange hands within a given time period, which is usually on a daily basis. Any analyst who follows securities in financial markets typically uses volume analysis.

Financial analysts must be able to understand and discern volume trends, especially because the statistics about the trading volume of an entire market, as opposed to a single holding’s trading volume, can signify different things about the market.

What Does a Change in Volume Signify?

Volume analysis can be analyzed to infer many trends in financial markets. Some of the trends include the following:

1. Trend confirmation

Trend confirmation is an important function performed by volume data. A rising volume usually implies that the market is rising. In order for buyers to keep pushing prices higher, they need to show high expectations. Increasing numbers of volume data can lead to such an increase in the enthusiasm of buyers.

A price jump in isolation cannot be considered a strong enough signal of investor confidence. However, when coupled with significant trading volumes, it sends a strong signal that investor sentiment is optimistic. An increase in prices coupled with decreasing trading volume can warn of a lack of investors’ interest in the markets, which can lead to a reversal of booms.

2. Bullish signs

Volume can be used in order to identify bullish signs in the market. For example, consider a situation where prices decline, but volume increases. Consequent to the occurrence, prices increase and then fall again.

If the decrease in prices the second time does not fall lower than the first low, the volume at the time of the second decline gets diminished. It is perceived as a sign that markets are bullish.

3. Price reversals

Consider a situation where the price of a security has moved in one direction for a long period of time, which may be a positive or negative price movement. If the prices change with lower amounts and the trade volume is heavy, it is usually perceived as a signal of a price reversal in the future. It means that if the prices were increasing over the previous long period, they might now be expected to change direction.

4. Volume and breakouts

A breakout is a change in market trends. In case there is an initial breakout from a trend in market movements, such as a range or other chart patterns, the volume can be a reliable indicator of the strength of that breakout.

A small change in volume or a steadily decreasing volume implies that there is little investor interest in the breakout. It suggests that the breakout is most probably a false one.

5. Liquidity

Volume is also an important indicator of liquidity in any market. A market with high trading volumes suggests that multiple buyers and sellers are ready to trade. It makes trading extremely liquid and desirable in the short term.

Volume Indicators

For investors who consider volume while making trading decisions, certain indicators are available to them. They include the Positive Volume Index (PVI) and the Negative Volume Index (NVI). They are index calculations that represent the impact of changes in volume on price. Both the PVI and NVI are calculated based on the trading volume of the previous trading day and the current market price of the security.

The PVI is adjusted in cases where the trading volume increases in relation to the previous day. Contrarily, when the trading volume decreases relative to that of the previous day, the NVI is adjusted.

A change in PVI suggests that high volume is the major driver of price changes. When NVI changes, it implies that the changes in trading volume have little or no effect on price fluctuations.

Related Readings

CFI is the official provider of the Capital Markets & Securities Analyst (CMSA®) certification program, designed to transform anyone into a world-class financial analyst.

In order to help you become a world-class financial analyst and advance your career to your fullest potential, these additional resources will be very helpful:

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• How to Read Stock Charts
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• Investing: A Beginner’s Guide
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