Trading volume: Key to better market moves

If you are a newcomer to the world of investing, comprehending the idea of trading volume can be a bit confounding. Nevertheless, it is an essential metric to bear in mind as you make investment choices, as it can provide insights into the overall health of the market and individual stocks.

Trading volume simply pertains to the number of shares that are bought and sold in a specific stock or market during a particular period of time. This can be measured on a daily, weekly, or monthly basis and is usually announced alongside other market data such as price, market cap and earnings.

Why is trading volume significant for traders?

Trading volume is a key indicator of market health, as it can provide us with hints as to the level of investor interest in a specific stock or market. If a stock or market is experiencing high trading volume, it indicates that many investors are buying and selling shares, which may signify that there is strong interest in that particular asset.

Global equity market turnover represents the total value of securities traded within a specific period. Higher market turnover typically indicates a larger market size with a greater number of participants. This, in turn, increases the overall trading volume as more buyers and sellers are actively engaged in the market. A report by World Federation of Exchanges (2020) showed that the global equity market turnover increased by 42.3 per cent year-on-year in 2020, reaching $101.6 trillion. The highest monthly turnover was recorded in March 2020 at $14.8 trillion, coinciding with the peak of the Covid-19 pandemic volatility.

Using trading volume in investment decisions

Trading volume is a technical indicator that represents the overall activity of a security or a market. Investors often use trading volume to confirm the existence or continuation of a trend, or a trend reversal.

Forex market showed that the average daily trading volume of foreign exchange markets was $6.6 trillion in April 2019, up from $5.1 trillion in April 2016. The most traded currency pair was EUR/USD, accounting for 24 per cent of the total turnover. This means that the forex market’s annual trade turnover is estimated at a whopping $2.4 quadrillion. For comparison, global GDP in 2019 amounted to roughly $142 trillion — 17 times smaller than the forex market.

Identification of breakouts

Breakouts occur when the price of a security moves beyond a significant resistance or support level, indicating a potential shift in market sentiment and the emergence of a new trend. Volume analysis plays a crucial role in confirming and capitalising on breakouts.

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Breakouts often coincide with a significant surge in trading volume. Traders look for a substantial increase in volume as the price breaks through a resistance level or support level. The higher volume suggests strong market interest and validates the breakout.

After a breakout, the price may experience a temporary pullback before resuming its upward or downward move. Traders watch for pullbacks accompanied by lower volume, as it suggests a healthy correction rather than a reversal. Lower volume during pullbacks indicates a lack of selling pressure or profit-taking, supporting the notion of a legitimate breakout.

Trading volume represents a critical element of stock market analysis, providing valuable insights into a trend’s strength. Through comprehension of trading volume and utilising it for better investment decisions, investors make more informed investment decisions and enhance their prospects of success.