5-06 Watch the Volume!

Volume is a key indicator of a stock, second only to the bid/ask prices. We briefly mentioned volume before, but as a refresher, this is the total number of trades that have been made on this stock in the last trading day.

Watching the volume of your stock can be pretty boring, and with most stocks volume stays pretty close the same average every day. However, looking at volume is your first indication if something is about to happen with your stock.

Market Sentiment

It is extremely difficult to identify what other traders are thinking. However, volume is a key indication on what is happening with other investors. If the volume for your stock starts increasing, it means more people are thinking about this stock – it is suddenly on the radar of other people who were not paying attention to it before.

This injection of new investors usually means the price is about to start moving – for better or for worse.

Volume is not a sure-fire indicator, but here are a few trends to watch out for:

Slowly Increasing Volume, Increasing Price

If the volume of the stock is slowly increasing as the price goes up, this can be an indication that there are more people who have heard of this stock because of its good performance and want in on the trend. This generally means this stock is becoming more popular, and more buyers on the market is pushing the price up due to supply and demand.

If you own this stock, this is usually good news.

Slowly Increasing Volume, Decreasing (or stable) Price

This trend is a worrying, if you already own this stock. If the volume is trending upwards, but the price is not increasing, it could be a sign that many people or investment firms have started short-selling this stock, expecting a steady drop in price.

It can also mean that many regular investors who have been holding it for a while finally decided to sell – more sellers than buyers will push the price down. This might be a good time to think about selling.

Sharp Spike in Volume, Increasing Price

Some news story mentioned this stock, and a ton of investors just became aware of it all at once. A huge number of new investors all discovered and bought this stock at once. This will probably cause the price to spike. Pay very close attention to see what news triggered this event – was there really a revolutionary announcement that made this company more valuable, or is this a mania building?

If you already own this stock, consider setting some limit orders to try to get out on top before prices crash back down.

Sharp Spike in Volume, Stable Price

If the volume suddenly increased, but the price has not changed very much, this can signal that there is a sudden battle between short-sellers and stock buyers over the fate of this stock. This means that very soon, the price of the stock is likely to either spike up or down as one side of that battle wins, the other loses.

This is typically a very dangerous place for an investor to be!

Sharp Spike in Volume, Decreasing Price.

The bad news is that if you already own this stock, you just lost a bunch of money very quickly. The good news is that your stop orders prevented your loss from being much bigger.

Market Tops

Besides a single stock, you can also look at the volume of the market as a whole to get some idea on what other investors are thinking. Market tops are subjective opinions that often quickly become fact, for better or worse.

How can you possibly identify a market top? Here are some suggestions that many experts believe will help you identify market tops.

• Closely watch the Dow Jones Industrial Average, NASDAQ Composite, and S&P 500. Pay particular attention to the relationship between volume and the index. At some point in a bull market, the volume will fade as the index continues to be strong—this is a bad sign that there aren’t any more buyers.
• Also watch the relationship between volume and your stock’s prices. Low volume doesn’t tell us much, but large volume helps support price movements.
• Track the above noted activity over a four or five day period. This trend often precedes an overall market downturn. Feeding upon itself, as an almost a self-fulfilling prophecy, the “mood” of the market also tends to change, becoming a bit of a bear rather quickly.

Rule #6 – Sell into rallies that have fading volume.

Try not to miss these market top indicators. You may lose profits you’ve already achieved. If you have been on a good streak, you don’t want to quickly change from offense to defense if you can avoid doing so. Identifying market tops can be a profitable component to your market strategy in both the short and long-term.