Every stock price that is quoted has both a bid and an asking price rather than one single price. There is someone who is actually bidding the bid price and someone else who is actually asking the asking price. The price you see when you look up the price of a stock is really the price that was transacted on the last trade, not the current bid and ask price. In order for that last trade to have occurred, there had to have been an agreement on price between a buyer and seller. If buyers are locked at the bid price and sellers are locked at the asking price, then trades would never occur. And if no trade ever occurred, there would be no volume in that stock. The act of trading is what creates volume.
Seeing the volume charted along with the stock’s price provides me with a clue in determining the amount and direction of the activity occurring in the stock. Another clue is knowing what the average volume is for a given day so I can know if today’s trading volume is above or below that daily average. Since I know that trading creates volume and volume only occurs when one of the traders breaches the spread between the bid and ask, I know that someone had to have flinched. As the trading volume increases I am seeing an increasing number of people who are flinching and completing the trade.
If volume starts to increase and the price starts to rise, I’m seeing buyers cross the spread and bid the stock higher. If volume starts to increase and the price starts to fall, I’m seeing sellers cross the spread and push the stock lower. Regardless of why these traders are creating volume and pushing the price higher or lower is something I may never know but I can visibly see what they are doing right there in the chart. I can see people act upon decisions they have made right there on the chart in real time. And the more volume I see tells me that an increasing number of traders are coming to the same decision and acting on that decision by trading the stock. Charts are a fascinating view on the decisions and behavioral patterns of stock traders.
Remember how all your life you were told to be a leader and not a follower? In the stock market being a leader is the quickest way to bankruptcy. At some point I’ll write more about the concept of trend following but for now the idea is to figure out which way the price and volume are moving and trade in that direction. If traders are pushing a stock higher I want to be long that stock and if traders are pushing a stock lower I want to be short that stock. I really don’t want to be on the wrong side of a trade. That’s detrimental to my financial health.
I can and have traded successfully throughout my career using only price and volume as indicators. But I’ve done this only when no other indicators were available. Today there are so many additional indicators that I can use to confirm my trading decisions that I rarely trade using only these two things - price and volume. Today I use momentum indicators and oscillators to confirm my trading decisions. I have my favorites and they’re wonderful tools to increase my probability of success and I’ll explain the ones I use in a future post.