Essential Strategies for Trading Volume

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Essential Strategies for Trading Volume

Volume, or the number of shares purchased and sold each day in any specific financial instrument, is one of the most accurate measures of money flow. For those unfamiliar with the markets, money flow is a word used by traders to analyze the overall supply and demand characteristics of a financial instrument in order to forecast its future direction.

High volume indicates increased interest in the name, and when accompanied with a rise in share price, it is often seen as an indication of strong upward momentum. Maintaining an eye on volume will keep you on the right side of the trade. Each of the indicators presented below utilizes volume as the major input and will show you how to integrate volume into your trading strategy in a realistic way.

Taking a Closer Look at Volume

Looking at the chart of Delta Air Lines, Inc. (DAL), you can observe a big surge in volume on Sept. 10, 2013, due to an announcement that the business will enter the S&P 500 stock market index. The sharp rise in the stock price, along with a surge in volume, signified increased interest in the stock and signaled the start of a strong upward trend.

In general, it is advisable to correlate a significant increase in volume with a significant change in the company’s fundamentals. Delta’s inclusion in the S&P 500 implied that significant index funds and mutual funds would be accumulating holdings. This would add a layer of underlying demand, pushing prices upward. Screens for surges in volume would have alerted active traders to this stock.

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Image by Sabrina Jiang © Investopedia2020

On-Balance Volume

The on-balance volume indicator, or OBV, is used to identify stocks that have had big increases in volume without a major change in stock price. When institutional investors begin purchasing shares, one of their aims is to restrict the price from rising so that their average entry price remains as low as feasible.

This is when the OBV indicator comes in handy. Before getting into an example, keep in mind that the indicator is computed by adding volume to the previous OBV value when the most recent closing price is larger than the prior closing price. If the closing price falls below the prior close, the volume is deducted from the previous OBV value. Consider the following example:

The price of Microsoft Corporation (MSFT) fluctuated sideways between $34.80 and $37.00 between late 2013 and early 2014. During this time, the OBV indicator was going substantially upward. The growing OBV indicates that traders were getting positive on the company, and a stock screen for rising OBV values would have enabled active traders to get in early before the price reached $41.11.

Image by Sabrina Jiang © Investopedia2020

Volume by Price

Another popular volume method is to employ the volume by price indication. Volume is often plotted near the bottom of a chart, as seen in the examples above. Volume by price is represented on the vertical axis so that traders may obtain an understanding of the volume transacted at different price points. Extreme volume levels may be utilized to identify regions where the smart money has chosen to take an active position. When paired with other indicators, strong volume changes at critical price points are often utilized by active traders to identify significant regions of support and resistance and may provide smart buying/selling signals.

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According to the volume by price indication, most trade in 2014 happened between $71.50 and $73, as seen in the chart of AmerisourceBergen Corporation (ABC) (blue bar used to illustrate the key trading range).Traders predict the stock to find support around $73 in the event of a major market sell-off. Because of the difference, there was limited volume between $74 and $76. Traders anticipate limited buyer support between these zones in the event of a decline.

Image by Sabrina Jiang © Investopedia2020

The Bottom Line

Volume is one of the most important indicators used by active traders to gauge money movement. As seen in the preceding instances, volume-derived indicators such as on-balance volume and volume by price may be utilized to develop profitable trading strategies. Combining trading signals created by volume fluctuations with a movement in a company’s fundamentals is often a good idea. Simple stock screens that discover equities with large volume fluctuations are excellent choices for traders wishing to build a watch list.

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