Why a stocks volume is important

   The stocks volume plays a very important role in determining future price movements of a given stock.  In fact many traders consider volume to be the 2nd most important market indicator.  (Only after price movements)

   I bet you want to know what volume is.  Volume is an indicator that you can put on your chart.  Unlike most indicators it is not developed by using a calculation.  It simply tells you how many times a given stock was traded within a given time frame. 

   For example if the Stocks volume for the day was 1,500,000 shares that means 1,500,000 shares were sold by someone and bought by someone on that day.

    Now at first glance this could appear to be an utterly useless piece of information.  How on earth could knowing how many trades happened help you? I’ll show you.

    Say stock ABC broke through a critical price level.  It was up 4% today.  That is a pretty nice move for one day.   Also since it broke through a critical level we would expect it to go up even more in the near future. 

    However let us also say that on that day 300,000 shares were exchanged.  On a normal day 1,000,000 shares are traded.  Volume was way below average for that day.

   That could mean all the big investors were not trading.  They could come in the very next day and decide they are bearish on the stock. They sell and cause a panic. So, the stock goes down the next day.

    This is why most investors will not buy a stock when it breaks a critical level unless volume is high.  Doing this we can be more certain that the majority of people think this stock will go up.  This offers a greater buy signal then the same signal without high volume.

   Also if a stock goes down with little volume it could mean the same thing.  The majority of investor were not trading.  When they come back they could see this stock and decide it is too low. So they  buy it  and the price goes up.

   Now this is not saying that if you see a stock go down and only had 1/3 of its average volume trading to go out and buy it.  We do not know what the other 2/3 of traders who normally trade this stock think about the stock. Why?  Because they didn’t trade that day.

     For all we know the other 2/3’s will come in the next day and decide the stock sucks and sell it.  Then the price plummets even further. 

   That is why traders should use volume only as a confirmation signal.  If you like a stock and it broke through a critical level with huge volume than maybe you can jump into that.  If that is what your system tells you.   Just don’t use volume as a solo indicator.

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