Interpreting volume depends upon the kind of trader you are and what kind of returns you wish to generate. Day trading and swing trading call for a very in depth look at volume, while investing requires the bare minimum. Studying volume helps investors find the best times of the day to trade and produce consistent profits.
The importance of volume
Professional traders put heavy importance on volume because of how it affects stock prices and liquidity. Investing in stocks with extremely low volume means that buying in will push up the price, and selling could be a difficulty. Profitable trading strategies would never recommend these stocks even to the most seasoned investors because good decisions and investments are replaced with sheer luck of the draw. Illiquid stocks can rise or fall whole percentage points just because of the time in between each trade.
Building a trading style on volume
Short term traders, such as day traders or swing traders, like to focus on volume as a way to find the best trading times. Looking at a NYSE volume chart, you see that trading spikes at the opening of the trading session, ebbs through lunch hour, then continues upward toward the close of the day. In 24/7 markets, such as the foreign exchange market, the situation is much different because each close is met with another open, though the highest volume is usually found when the US and European markets overlap for a few short hours in the middle of the day.
What does high or low volume mean?
For the most part, higher or lower volume just means more or less trading, and this can be due to a variety of reasons. High volume may be the result of day traders and swing traders trading a volatile market, or a large investor entering or exiting a position. As long as volume remains high enough for ample liquidity, the impact of volume is very little on the financial markets.
Developing a trading plan
It should be noted in your trading plan what kind of volume would warrant a particular position. If you feel that volume of 50,000 shares is needed to buy into a stock, note it in the plan and don’t break it. Many traders look for at least 30,000 shares traded daily to decide how liquid an investment is. A complete trading plan should also include when to trade, which is often decided solely on volume. Risk and money management tips should be considered, especially if you plan to invest in illiquid securities.