When it comes to trading the financial markets, everyone knows the importance of watching the price action of the underlying asset. However, there is a major component that traders and investors should not overlook. Often times, tracking a security's trading volume is just as important, if not more so, than its price.
Trading volume is a measure of how many times shares exchange hands on the open market. Knowing whether a security has strong or weak volume can tell a trader a lot about the market's opinion on these moves. This week, Toni Turner of TrendStar Trading Group discusses what traders and investors can learn from tracking volume, and how they can apply that information into their strategies.
EQ: Why is it important for traders to track trading volume when monitoring stocks?
Turner: Volume provides some of the most important signals that we can receive, when we trade. I like to say that volume measures how many people are at a party. We've all gone to parties where, unfortunately, a lot of people didn't show up and it's just not as much fun because the energy isn't there. So when we see volume come into a stock or an ETF or whatever you're trading, especially at the proper place in a setup as in perhaps a breakout of a consolidation, then we know there are a lot of people coming into this party. That certainly helps us measure the level of enthusiasm and gives us added information on whether we should enter a trade, or not.
Volume gives us totally unique signals. Its signals can be compared to getting a second opinion. That’s because volume is not a derivative of price, and almost every indicator that we use on our charts is a derivative of price. Volume is unique in that way. It tells us things that price may not be telling us, and we can look at it and determine if volume is confirming the price action or if volume is not confirming the price action.
EQ: What are examples of volume signals or indicators that traders can use?
Turner: Joe Granville, a renowned market expert, created a chart indicator called the "On-Balance Volume". It's an excellent and simple indicator that we can use on our charts to read volume signals. It's a single line indicator plotted over volume spikes. As one can imagine, if it's trending higher then it's positive and it tells us that buying power is coming into the stock. If on-balance volume is moving in a downtrend, it tells us money is coming out of that stock. Joe Granville also said that volume precedes price, so the on-balance volume is a valuable indicator that can give us bullish or bearish divergences. A divergence is when the asset price moves in the opposite direction of the indicator or related measure.
EQ: You mentioned the party with no one there. In the case, what should traders be aware of when a stock has low trading volume?
Turner: When you see a stock making new highs on low volume, many times that can indicate that there's not a lot of people at the party anymore, and that the neighbors have called the cops. The party is over. When that happens, then that new high may not be sustainable. That is one signal I will use. A really good signal that I use for a lot of intraday trading is when price is falling. So say we're short a stock and price is falling really hard on an intraday chart. If I see a huge volume spike appear on that chart, especially if price is coming into support, then I will definitely cover my position because that mean buyers are coming into that stock. Again, a big move down on really high volume can tell me to look for prior support and, if I'm short, to cover that position.
EQ: In a way, trading volume can serve as a gauge for the supply and demand for an underlying asset. Can you discuss the importance of that?
Turner: Supply and demand are a function of fear and greed. Fear and greed run the financial world, so we definitely want to connect the market's fear and greed to supply and demand, and move it into volume. Sometimes volume doesn't tell us much. Sometimes it's just average volume for that particular stock, and for that particular designated time period. But many times, if we see extremely high volume or extremely low volume appearing in a stock, it definitely can indicate that there is going to be a change or shift in the current trend. We want to look and correlate it with price to see if that is fear and greed coming into a stock that will manifest on the chart as support or resistance.
EQ: Do you have any additional advice for traders on understanding volume?
Turner: Remember that volume can help you identify the strength of an uptrend or downtrend. If you read the signals correctly, volume can help you enter a trade, manage it, and exit that trade at a good time. So I do believe that learning how to read volume signals is important. For anyone who wants to learn more, we have a recorded online seminar on my site that people just download that's focused specifically on this topic. It's called Volume Signals Can Make You Money! and its goal is to help people learn how to read volume signals properly. The content can add a terrific amount of value to a trader and investor's skill set.
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