Number of Trades Can Reveal Supply and Demand; Looking for Conviction
Every day, billions of stocks trade hands around the world. To give you an idea, the 30 stocks in the Dow Jones Industrial Average alone have been known to trade more than a combined 6.5 billion shares in a single day.1
Six and a half billion sounds like a lot of shares – but is it? How would you know? Why would anyone care?
In fact, the number of shares traded on a given day, also known as volume, can be just as important as the direction of stock prices on the same day.
Market Snapshot
On a very basic level, volume can be a quick way to assess what is going on in the market. Rallies and routs both tend to be accompanied by higher-than-normal volume. In the example mentioned above, the single-day (August 16, 2007) volume of 6.5 billion shares was an all-time high for the Dow, which had been trading an average of 3.2 billion shares a day during the preceding six months. On that day, news about subprime mortgages had the market’s full attention and triggered a massive sell-off. Selling outpaced buying, and the index closed below 13,000 for the second day in a row, despite having broken the 14,000 barrier for the first time barely a month earlier.2
Supply and Demand
When it comes to a single security, unusual volume can indicate changing supply and demand. A security that is trading above its average daily volume and increasing in price is probably in demand by institutional buyers, whose actions are closely watched. A falling price paired with above-average volume may indicate falling demand and institutional selling.
When a security’s price changes rapidly, the change is usually considered significant if it is supported by higher-than-normal volume. A major price change that is unsupported by volume might indicate activity by something other than market forces, and the possibility that the price change is temporary. On the other hand, a changing price that is backed up by significant volume is said to have conviction because the market is paying close attention.
It’s fairly easy to grasp the importance of trading volume, but not so easy to make portfolio moves when volume fluctuates. To the amateur investor, it is an interesting indicator, but to professional traders and money managers, it is an indispensable aspect of investment decisions.
1–2) Yahoo! Finance, 2008 (Dow Jones Industrial Average total return for the period 10/1/1928 to 12/31/2007). The performance of an unmanaged index is not indicative of the performance of any particular investment. Individuals cannot invest directly in an index. Past performance is no guarantee of future results.