Trading Volume, Why is it So Important?

Trading volume reflects the overall activity of the market, indicating the sheer amount of buying and selling of securities. Next to price, it is one of the most closely watched indicators.

Specifically, trading volume represents the total number of stock shares, bonds, or commodities futures contracts traded during a certain period of time.

The major exchanges report trading volume figures on a daily basis, both for individual issues trading and for the total amount of trading executed on the exchange. Trading volume indicates market liquidity and the supply and demand for securities.

Trading volume also reflects pricing momentum. When stock market activity—i.e., volume—is low, investors anticipate slower moving (or declining) prices. When market activity goes up, pricing typically moves in the same direction.

Low volume of a security, even if it's rising in price, can indicate a lack of conviction among investors. Conversely, high volume of a particular security can indicate that traders are placing their long-term confidence in the investment.

Why is Trading Volume Important?

Certain types of investors who subscribe to the "technical analysis" school of thought place enormous importance on the amount of volume that occurs in the trading of a security or commodity futures contract.

Trading volume also serves as a warning as to whether a stock is on the verge of breaking into upside territory (high volume) or into a downside trend (low volume). High volume also gives investors more time to determine when it's the right time to sell for a profit.

A dramatic rise in volume is interpreted to signify future sharp rises or drops in price, because it reflects increased investor interest and sustained momentum. Low volume can generate price volatility and mirror factors that, from an investment standpoint, are ephemeral and untrustworthy.

Take note: Extremely low volume sometimes attracts scam artists who are determined to manipulate the price of the stock, because their trading will exert an outsized influence.


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