How to Use Volume Trading Strategies to Detect New Trends If you are somewhat new to the world of trading, most of the material you read has likely been centered on following stock prices over time. Changes in the price of a stock, after all, is what will determine whether or not a given position was actually profitable. The only way to become a successful trader is to exit positions at a higher value than you entered into them. Otherwise, your return on investment will continue to suffer. However, though it is obviously very important, the price of a stock is really just one component of a much more interesting story. Whether a stock has increased in price or decreased in price, you ought to ask yourself why such a change has occurred. Does it have something to do with the fundamental value of the company? Are there any relevant market trends at play? Or are these changes a consequence of a much deeper narrative that requires a closer look? In addition to the price of the stock, many traders have discovered that paying attention to volume is something that is incredibly important. As the amount of times the stock is traded over time (the trading volume) begins to change, this will likely have a direct impact on the actual price it is being traded at. Though the relationship between trading volume and price is almost never a linear one, its importance is something that all seasoned traders cannot possibly deny. In this article, we will discuss the nuanced practice of volume trading. Beyond traditional price graphs, volume traders pay attention to changes in trading volume in order to detect a price change before it actually occurs. By making a conscious effort to understand volume trading strategies, you will be able to detect trends earlier and make more profitable decisions. What determines the price of a stock? As is the case with many things in the world of finance, the true value of a stock is how much someone is actually willing to pay for it. When more people have interest in purchasing a stock (at its current spot price), that stock will become fundamentally rarer and the price will consequently increase. On the other hand, when fewer people are interested in purchasing at the current stock price, demand will be recognized as having decreased and the price will go down. At any given point in time, anyone who is interested in purchasing a stock can issue a “bid”. If the stock is currently trading at $100, an interested trader might issue a bid at $99.95, which means the trade will not be executed until the price drops below that level. On the other hand, anyone who owns the stock and is interested in selling can
issue an “ask” offer, which—in this particular example—may be somewhere around $100.05. The difference between the highest bid and the lowest ask in the order books is referred to as the bid-ask spread. Whenever the highest bid price meets or exceeds the lowest ask price, a trade will be made. The stock price that you will find reported online indicates the most recent bid-ask match that actually occurred. What is the relationship between volume and price? Once you are able to understand the fundamentals of stock valuation, the relationship between volume and price becomes much more obvious. As the bid volume (the number of bids at a given price) becomes higher than the ask volume, the price of the stock will begin moving upwards. On the other hand, once the ask volume becomes higher than the bid volume, the stock price will trend downwards. If a stock has been trading at a higher volume, this will usually indicate that bid volumes are trending upward and will ultimately be reflected in the stock price. However, the price itself is not always so quick to act—there may be a delay between increases in bid volumes (at the spot price) and when changes in the stock’s price have actually occurred. This supposed “delay” is where many volume traders attempt to earn a profit. Price and volume are both directly related to the money flow (one of the most highly quoted figures on Wall Street). The money flow is a figure that indicates the average of high, low, and closing prices for a stock multiplied by the amount of times the stock was traded in a given day (trading volume). Though there are many exceptions to this rule, if the money flow is higher than it was the day before (or other periods of time), this may indicate that demand is on the rise and the stock may be experiencing a brief upward trend. How can I react to increases or decreases in trading volume? Now that you understand money flow and the relationship between price and volume, you are likely asking yourself how you ought to react to changes in trading volume. Does an increase in trading volume always result in an increase in price? Does a decrease in trading volume always result in a decrease in price? The answer to both of these questions is obviously no, otherwise volume would be the only variable that traders (especially day traders) pay attention to. However, the relationship between these variables is undeniable. Increases in executed trading volume and especially money flow are highly correlated with price increases. At the very least, these changes are also strongly correlated with high levels of volatility, meaning
that while there will be some short term exposure to risk involved, there will also be plenty of opportunities for you to earn significant returns on your investment. How can I use volume trading strategies increase the performance of my portfolio? Outside of fundamental increases in company value, there are many other reasons why stock trading volumes might increase. Factors such as the investor “herd mentality”, random appearances in major news sources, and price manipulation tactics can all contribute to otherwise unexplainable changes in trading volume. Because of this, it is important to be mindful before blindly jumping into a given position. In general, volume trading strategies ought to be used alongside other price-based methods of monitoring the market. Here are some of the ways volume trading strategies can immediately increase your overall portfolio performance. · Pay attention to any updates of the major indexes (DJIA, S&P 500, Russell 2000, etc.); companies that get boosted into a major index will almost always experience increases in trading volume and price. · Follow any prospective company’s volume by price indicator—these are charts that allow you to compare volume and price patterns over time and identify specific instances of resistance and support. · Apply the same technical analysis techniques to volume that you normally do to price. This may include momentum trading, swing trading, harmonic pattern trading, and various others. The quantitative trends will likely remain consistent. · Pay close attention to financial news. Markets and stocks rarely exhibit “random” behavior—there is almost always an underlying explanation. · Recognize the value of the money flow. This figure (high price, low price, closing price, and daily volume) helps combine multiple relevant variables and is an excellent resource for anyone who needs to make quick trading decisions. As your volume trading strategy becomes more comprehensive, you will become less likely to be blindsided by an unexpected event. Conclusion Anyone who hopes to become an active investor—and identify price changes before they have actually occurred—will certainly benefit from learning the relationship between price and volume. Changes in trading volume are almost always reflected in price and by paying careful attention to the money flow and other trends, you may be able to eventually beat the market.