Investors use volume to determine market liquidity and pricing momentum. Get insights on how volume can add value to your investment portfolio.
Toronto Stock ExchangeDec. 09, 2020
A stock transaction occurs when a buyer (or buyers) and a seller (or sellers) agree on the price and number of shares of security to exchange. The quantity of shares traded is referred to as volume. Each "round trip" transaction is counted only once when measuring volume. If one investor buys 500 shares and another sells 500 shares, the volume that will be recorded in the records is 500 — not 1,000. Similarly, volume doesn’t refer to the number of parties involved in a transaction. There could be a single investor on the other side of the trade or multiple investors.
Throughout the trading session, both the price and the daily volume are recorded and updated in real-time for all market participants to see. Many brokers offer additional information, such as average daily trading volume. It's an indicator of market liquidity and pricing momentum, and is one of the most closely watched indicators next to price.
High volume versus low volume
Trading volume is one criteria that investors might use to decide whether to buy or sell a security. High volume can be an expression of long-term investor confidence while low volume could signal lack of conviction in the security.
Another consideration for investors is whether market activity can accommodate their portfolio strategy.
For example, let’s say an investor wants to buy 100,000 shares of a stock that normally trades only 20,000 shares a day. It might take a week (or more) for the investor to accumulate their desired position of 100,000 shares. It's also possible that this trade could force the stock price to trend upward because of the significant added demand for the stock.
On the other hand, if an investor wants to buy 100,000 shares of a stock that normally trades 20 million shares a day, the transaction would likely be completed in seconds given the large number of market participants.
Why investors should care about volume
On the surface, a security’s trading volume at any given time doesn't tell you much. But once it’s placed into context, it might signal a buying or selling opportunity.
Suppose you're following a stock that trades an average of 1.5 million shares per day. One day, you notice that just three hours into a trading session, the volume has already exceeded 2 million shares. Day traders and other short-term traders might be attracted to this scenario and glean that something is going on behind the scenes.
If a stock is rising on unusually high trading volume, it could imply that buyers are speculating that good news lies ahead for the company. For example, perhaps an institutional hedge fund’s research team concluded the stock could be an acquisition target. Based on the assumption their analysis is correct, they're willing to bet significant dollars to buy up as much as they can. In this situation, a day trader would be more tempted to buy the stock and hope to ride the price higher for a quick gain. On the other hand, if a stock is tumbling on unusually high trading volume, this could suggest that investors are speculating that bad news is imminent.
It’s important to understand how trading volume is calculated and how it affects your investment and trading strategy. In the end, it’s only one tool out of many that can add value to your investment decisions.