What is Trading Volume?
Volume represents the level of activity and interest in a particular stock. Each unit of volume represents a transaction between a buyer and a seller. High volume indicates a high level of interest and participation, while low volume indicates less interest. Volume is a crucial secondary indicator that should be analyzed alongside price action.
Volume and Trend Confirmation
According to Dow Theory, volume should confirm the trend. This means:
- In a healthy uptrend, volume should generally be higher on up days (when the price closes higher) and lower on down days.
- In a healthy downtrend, volume should generally be higher on down days and lower on up days.
If volume is not confirming the trend (e.g., an uptrend with declining volume), it can be a warning sign that the trend is losing momentum and may be due for a reversal.
Volume and Chart Patterns
Volume is also critical for confirming chart patterns. For a breakout from a pattern (like a triangle or a head and shoulders) to be considered valid, it should ideally occur on a surge in volume. A breakout on low volume is less convincing and has a higher probability of being a "false breakout" or a fakeout.
On-Balance Volume (OBV)
The On-Balance Volume (OBV) is a popular momentum indicator that uses volume flow to predict changes in stock price. It is a running total of volume, where volume on up days is added and volume on down days is subtracted. The direction of the OBV line can be used to confirm the price trend or to spot divergences that may signal a reversal.
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