What Is Trading Volume?

Trading volume is a critical indicator of market activity that is closely monitored by traders and investors alike. Understanding trading volume can provide valuable insights into market trends, investor sentiment, and potential trading opportunities. In this article, we will explore what trading volume is and how traders can use it to inform their trading decisions.

What Is Trading Volume?

Trading volume refers to the total number of shares, contracts, or units of an asset that are bought and sold during a given period of time. It is a measure of the level of activity in a particular market or asset and can be analyzed in different ways, most commonly as volume-by-timeframe and volume-by-price.

Volume-by-Timeframe (VBT)

Volume-by-timeframe is used to display the trading volume of a security over a specific time period. It involves plotting the trading volume of a security in each individual time interval, such as minutes, hours, days, weeks, or months, rather than simply displaying the total volume for the entire trading session.

On a volume-by-timeframe chart, each bar represents a specific time interval and the height of the bar indicates the volume traded during that interval. The bars are usually color-coded to indicate the strength of buying and selling activity. The chart is typically located below the price chart, or it can be overlaid on top of the price chart.

Volume-by-Price (VBP)

Volume-by-price, also referred to as volume-at-price or volume profile, is used to display the trading volume of a security at different price levels. It involves plotting the total volume of a security that has been traded at each price level, rather than simply displaying the total volume for the entire trading session.

On a volume-by-price chart, each bar represents a specific price level and the height of the bar indicates the volume traded at that level. The bars are usually color-coded to indicate the strength of buying and selling activity. The chart is typically located on the right-hand side of the price chart, either as a separate chart or as an overlay.

There are several ways to measure volume-by-price, the most common being based on the visible range, or the time period on your screen. In TrendSpider, anchored volume-by-price (AVP) allows traders and investors to anchor the chart to a specific point in time. Instead of displaying the volume traded at different price levels over a specific period of time, the AVP chart displays the volume traded at different price levels from a specific anchor point. This anchor point can be set by the user to correspond to a significant event, such as an earnings announcement, a major news release, or a technical level on the chart.

Volume shelves or volume nodes are areas on a volume-by-price chart where there is a concentration of trading volume. These areas can be identified by looking for horizontal bars or clusters of bars that represent high volumes of trades executed at specific price levels.

1. Volume shelves are typically areas of price consolidation where buyers and sellers have traded large volumes of shares, resulting in a high concentration of trading activity. They can represent significant support or resistance levels, where the market has previously struggled to break through, making them important levels to watch for potential breakouts or reversals.
2. Volume nodes are similar to volume shelves but represent areas where the trading volume is the highest. These areas can be seen as a peak or high point on the chart, indicating a level where there has been significant buying or selling activity. Traders and investors may use volume nodes as potential areas for taking profits or entering new trades, depending on the market conditions and their trading strategy.

Volume Trading Strategies

There are several strategies that use trading volume as a key indicator for making trading decisions. Here are some examples:

1. Support and Resistance Levels: Support and resistance levels are key price levels where a stock tends to either bounce or break through. By analyzing trading volume at these key levels, traders can determine whether there is enough buying or selling pressure to break through a level. Higher trading volume at a support or resistance level can indicate that it is more likely to hold or break.
2. Breakout and Breakdowns: Breakout and breakdown trading strategies use trading volume to identify potential price movements outside of a security’s current trading range. When a security’s price breaks through a key level, such as a resistance level, with high trading volume, it can signal a potential breakout or trend reversal. Conversely, if a security’s price falls through a key support level with high trading volume, it can signal a potential breakdown or downtrend.
3. Trend Strength: Trading volume can also be used to identify the strength of a trend. For example, a trend that is accompanied by high trading volume is typically seen as more reliable than one with low trading volume. High trading volume in an uptrend can signal strong buying pressure, while high trading volume in a downtrend can indicate strong selling pressure. Traders can use trading volume to confirm the strength of a trend and make more informed trading decisions.
4. Volume Divergence: Volume divergence is a trading strategy that compares changes in price with changes in trading volume. If the price of a security is rising but the trading volume is decreasing, it may indicate that the trend is losing momentum and a reversal could be imminent. Conversely, if the price is falling but trading volume is increasing, it may indicate that a trend reversal or breakout is coming.
5. Volume Reversals: Volume reversal is a trading strategy that looks for a sudden increase in trading volume after a prolonged period of low volume trading. This sudden increase in volume can indicate a potential trend reversal or breakout, as traders start to enter or exit positions. Traders using this strategy typically look for a spike in trading volume that is significantly higher than the average volume for a particular security.

These are just some of the trading strategies that incorporate trading volume as a key indicator for making trading decisions. While trading volume alone is not always a reliable indicator, it can provide valuable insights into market trends and price movements when used in conjunction with other technical and fundamental analysis tools.

Volume-Based Indicators

Volume-based indicators are technical indicators that use volume data to analyze market behavior and identify potential trends and price movements. Here are some common volume-based indicators:

1. On-Balance Volume (OBV): OBV is a popular volume indicator that measures buying and selling pressure by adding or subtracting the day’s volume, depending on whether the price closes higher or lower than the previous day. It can be used to confirm trends and potential reversals.
2. Chaikin Money Flow (CMF): CMF is an oscillator that measures buying and selling pressure by analyzing both price and volume data. It can be used to confirm trends and identify potential breakouts.
3. Volume Weighted Average Price (VWAP): VWAP is a moving average that takes into account both price and volume data. It is often used by institutional traders to determine the average price at which a stock is traded throughout the day.
4. Accumulation/Distribution Line (ADL): ADL is an indicator that uses volume and price data to measure buying and selling pressure. It can be used to confirm trends and identify potential reversals.
5. Money Flow Index (MFI): MFI is a momentum indicator that uses both price and volume data to measure buying and selling pressure. It can be used to identify potential reversals and overbought/oversold conditions.
6. Volume Rate of Change (VROC): VROC is an oscillator that measures the rate of change of trading volume over a specified period of time. It can be used to confirm trends and identify potential breakouts.

These volume-based indicators can provide valuable insights into market behavior and help traders make more informed decisions. However, it’s important to use them in conjunction with other technical indicators and fundamental analysis to avoid false signals and potential losses.

The Bottom Line

In conclusion, trading volume is an important tool that traders can use to make informed trading decisions. By analyzing trading volume, traders can gain valuable insights into market trends, identify potential breakouts and breakdowns, and determine the strength of a trend.

However, trading volume should not be used in isolation, and traders should always use it in conjunction with other technical and fundamental analysis tools. It is also important to remember that no trading strategy can guarantee success, and traders should always practice proper risk management and adjust their strategies based on changing market conditions.

With these considerations in mind, trading volume can be a valuable tool in a trader’s toolkit, helping them to make more informed decisions and potentially increase their profitability in the markets.