Trading Stocks On Price And Volume

What does volume tell the stock trader ? The main thing it tells us is how much interest is in a stock. When volume spikes it gives us an idea of the emotional excitement, or “irrational exuberance” to quote Alan Greenspan, there is for a certain stock. Stock chart volume is simply the number of shares traded during a certain period of time and when it spikes it is a signal to the trader that some sort of news has been released, whether it be good or bad.

When a stock is trading on high volume there are many traders involved. It becomes easier to trade in and out of. Volume spikes usually bring in the day traders, more traders in a stock usually means the trading becomes more volatile.

Here is the chart from Yahoo finance, of a biotech stock that I traded, BLRX normal daily volume before an announcement on January 24th, 2012 was minimal. January 24th, they released news volume spiked up to 253,000 shares traded that day and the share price rocketed up. The spike brought in traders long and short (me) and over the course of the next few days money was made.

Notice the massive increase in volume and as it decreases the price declines. This was a case of irrational exuberance. The news released was a licensing agreement for a Hepatitis C treatment still in pre-clinical studies. For those of you that do not know what that means, it’s in animal studies and as of yet has not been tested in humans, as such it is many (10 or so) years from making it to the market and making any revenue for this company.

The only time volume is going to help in trading is when it is combined with a price movement. There is a saying that “volume precedes price”, many times you will see volume pick up before the move in price. The increased volume is showing that interest is building over the expectation of some news.

Trying to interpret volume on a chart is hard, it is not until you have some price action that you can be sure what the volume was telling you. Then do your due diligence to see if the price movement is rational or not.

Another way to use volume is to use a PBV (price by volume) chart. This helps traders gauge the level of interest in buying and selling at various price levels. PBV charts can be created using online charting services from websites such as StockCharts.com and BigCharts.com. They are pretty easy to understand.

A PBV chart will show you:

  • Volume Strength which indicates the amount of shares traded at a certain price level indicated by the horizontal length of the PBV histogram (Histogram is a graphical representation, similar to a bar chart used to demonstrate how many of a certain type of variable occurs within a specific range.)
  • Volume by type shows the number of shares bought compared to the number of shares sold. This is indicated by the two different colors seen on each bar.
  • Successful reactions or tests which refers to the number of times that a stock successfully tests and “bounces off” a given level.
  • These three things will allow you to determine the strength of a certain price level. Once you know this, you can combine this information with trendlines and other indicators to find support and resistance levels.

So whether you trade support and resistance, play gaps or have your own technique, whether you are long or short, may all of your trades be profitable!

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