Trading Volume Explained for Dummies

  Trading volume, also known as the volume of trade, trade volume, or volume in trading, refers to the number of shares, bonds, contracts such as options and futures, and different types of commodities traded during a given trading period. Put in other words, trading volume indicates the total number of a particular security or commodity traded between buyers and sellers during a specific trading period, such as a trading day. Trading volume is most often used in the trading of shares.  

Trading volume as a key indicator of market liquidity and activity

  Any trade requires a buyer and seller in order for a transaction to be executed. The number of securities or commodities traded in each transaction contributes to the volume of trade. Noteworthy, it is not the number of transactions that represents the trading volume. For example, a trade-in in which one buyer buys one hundred shares in one transaction represents the same volume in trading as when five buyers purchase twenty shares each in five different transactions. Trading volume is a key indicator of the liquidity and activity of particular security like shares or bonds, as well as a range of commodities. When securities, contracts, or commodities are actively traded, their trade volume is high, indicating it needs little effort for buyers and sellers to communicate and perform transactions. Put differently, a higher volume of trade is a signal of better execution of orders and higher liquidity. Conversely, when security, contract, or commodity is less actively traded, its volume is described as low, indicating lower liquidity and activity in a financial market. The volume in trading can be impacted by various factors, such as political or corporate announcements, as well as serious events like the Covid-19 pandemic. Typically, the volume shows a tendency to be highest close to the daily opening and closing of a financial market, as well as the first and last day of a trading week.  

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How is trading volume expressed?

  Financial and commodity markets report the trading volume of securities and commodities at specific times during a trading day. Typically, as frequently as once every hour for the duration of a trading day. Volumes in trading reported every hour are estimates. Likewise, the trade volume recorded at the close of a trading day is also an estimate. The actual figures of a trading day’s volume are released the following day.  

Example of trading volume

  Let us say Willy and Billy are two traders who trade shares on a specific stock exchange. Willy purchases 600 shares of company Well Done and sells 350 shares of company Going Strong. Billy buys the 600 shares of company Well Done from Willy and sells 200 shares of company Perseverance to another trader. The total trading volume of the different transactions would be 1 150 (600 shares of company Well Done + 350 shares of company Going Strong + 200 shares of company Perseverance.) The 600 shares of company Well Done traded between Willy and Billy are only counted once.  

Trading volume as a technical indicator for traders

  Traders use various technical indicators to analyse the performance of a security or commodity. Trade volume is one of the most straightforward and uncomplicated technical indicators utilised by traders. As a technical indicator, trading volume enables traders to make the right trading decisions. It typically tracks a security’s average trading volume on a daily basis over a short-term (5 minutes) or a longer-term period. Trade volume is especially helpful when large price increases or decreases occur. When a drastic jump in the price of a security or commodity occurs, a high trade volume can serve as a stimulus. Increased trading volumes associated with such exceptional price changes tend to strengthen faith in the real value of the security or commodity, reinforcing support for the value. The strength or weakness of a price movement of a security or commodity can be used by traders to determine the strength of a price movement. The higher the volume the stronger the momentum of the price change. Typically, traders are more inclined to follow strong price increases. However, when a trader detects that a security’s price increases but its trade volume decreases, it is considered an indication that the price trend is diminishing, indicating the beginning of a price reversal.  

Trading volume displayed on a bar chart

  The trading volume of a security is typically displayed by vertical bars on a bar chart, representing the volume for the specific incremental time frame on the chart. Volume bars are generally coloured green, or red. Green indicates net buying volume while a red represents net selling volume.

Advantages of trading volume

 

• It is a key technical indicator used by traders to examine the price history of a security.
• It indicates the level of liquidity associated with specific security or commodity.
• Trade volume enables traders to determine the point of entry and exit regarding particular security or commodity.
• It can be used to measure financial instruments such as shares, bonds, futures, and options, as well as commodities and forex.
• Trading volume is an important aspect to consider when traders are deciding on intra-day trading.
• It helps to ascertain the strength of price movements and to identify a trend. When a price movement coincides with a proportionate increase in volume, it is considered a more significant price movement than one that is not.

 

Disadvantages of trading volume

  Trade volumes reported hourly during a trading day are only estimates. For a final figure, traders have to wait until the start of the following trading day.

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