Basic strategy of trading volume

The number of stocks bought and sold in any given financial instrument every day, called trading volume, is one of the most accurate ways of measuring the flow of funds. For those who are new to the market, traders use the flow of funds to determine the overall supply and demand characteristics or financial instruments to predict their future direction.

High volume indicates increased interest in the name, and if it is combined with rising stock prices, it is often used as a signal of strong upward momentum. Paying close attention to trading volume will ensure that you are in the right position for trading. Each of the indicators discussed below uses trading volume as the main input and will provide you with a practical perspective on how to incorporate trading volume into your trading strategy.

Watch the volume carefully

Take a look at the Delta Air Lines (DAL) chart shown in the figure below, you can see that the trading volume surged on September 10, 2013, thanks to the company’s announcement to join the Standard & Poor’s 500 stock market index. The strong rise, coupled with the surge in trading volume, indicates that interest in the stock has reignited and marked the beginning of a strong rise.

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Generally speaking, it is best to combine strong sales growth with a strong shift in the company’s fundamentals. As far as Delta is concerned, the addition of the Standard & Poor’s 500 Index indicates that large index funds and mutual funds will increase their positions. This will add a layer of potential demand, thereby pushing up prices. The screening of soaring volume will attract the attention of active traders.

Balance

The Balanced Volume Index, usually called OBV, is used to find stocks whose trading volume has increased sharply without significant changes in their stock prices. When institutional investors start buying stocks, one of the goals is to avoid pushing up prices so that they can keep the average entry price as low as possible.

This is where the OBV indicator is very useful. Before delving into the example, it is important to note that when the most recent closing price is greater than the previous closing price, the indicator is calculated by adding the trading volume to the previous OBV value. If the closing price is lower than the previous closing price, the transaction volume is subtracted from the previous OBV value. Now, let’s look at an example:

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It can be seen from the chart of Microsoft Corporation (MSFT) that at the end of 2013 and early 2014, the price was trading sideways between US$34.80 and US$37.00. Please note how the OBV indicator rose sharply during this period. The increasing OBV shows that traders are beginning to be optimistic about the stock, and the screening of stocks with rising OBV values ​​will enable active traders to enter the market as soon as possible before rising to 41.11 US dollars.

Quantity by price

Another common strategy for using volume is to use volume based on price indicators. In most cases, the trading volume is plotted at the bottom of the chart, as shown in the example above. In the case of price-based trading volume, it is plotted on the vertical axis so that traders can understand the trading volume at different price points. Levels with extreme trading volumes can be used to identify areas where smart money decides to actively pursue positions. Active traders often use strong volume movements at key price points to identify key support and resistance areas, and when combined with other indicators can generate strategic buy/sell signals.

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As you can see from the chart of AmerisourceBergen Corporation (ABC), most of the transactions in 2014 occurred between $71.50 and $73. This is determined by the price indicator (the blue bar used to illustrate the key trading range). The amount is determined. If there is a broad market sell-off, traders expect the stock to find support near $73. Please note that due to the gap, the volume between $74 and $76 is very small. Traders expect that if there is a pullback, buyers in these areas will hardly provide support.

Bottom line

Trading volume is one of the key indicators used by active traders to measure the flow of funds. As you can see in the example above, indicators derived from the use of trading volume (such as balance trading volume and price-based trading volume) can be used to create profitable trading strategies. It is usually a smart idea to combine trading signals generated by changes in trading volume with changes in the company’s fundamentals. A simple stock screen used to identify securities whose trading volume changes drastically is ideal for traders who wish to create watch lists.

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