Wednesday, July 1, 2020

How a Stock's Volume Can Affect Its Price

Investing in stocks used to be a bit of an ordeal, with investors having to go into brokerage firms such as Charles Schwab or Scottrade and sit down with a broker in order to make a trade.

Fast forward to 2020, and the advent of smartphones and apps like Robinhood have made commission-free trading a breeze for investors of all ability levels. Combined with the economic slowdown caused by the COVID-19 pandemic, and a record number of retail investors have started trying their hands at day trading stocks.

While the convenience of at-home trading is an exciting way for investors to make some money and build their wealth, simply having the ability to trade stocks does not make someone a professional. In order to enter into profitable trades, investors must understand how to analyze stocks.

Due to the frequency of making trades, the day trader will be less concerned with analyzing a stock’s fundamentals, such as its free cash flow, price-to-earnings ratio, and debt-to-asset ratio, as he or she will be in performing technical analysis on a stock’s price trend. By looking at charts and understanding technical patterns and indicators, day traders can make tidy profits in one day, even when trading companies that are fundamentally weak.

While technical patterns can show up on price charts, volume must be considered simultaneously to help confirm or reject whether or not the pattern truly exists and whether or not the stock’s future price will perform as expected.

To give a simple illustration of how volume affects stock price, it is helpful for traders to understand how bullish and bearish trends perform as related to volume.


How Volume Influences Bullish Trends


In stock market lingo, bullish refers to “buying,” or a signal that investors are optimistic about a stock’s future performance. This can also be referred to as “long.”

During a bullish trend, there is a high volume of stock being bought, causing the price of the stock to increase. Essentially, the demand to buy is greater than the demand to sell, and shareholders can charge increasingly high prices for their shares.

When the price reaches a point where shareholders are happy to hold onto their stocks and buyers are not quite so fervent to buy, the volume will decrease drastically. This allows some time for traders to catch their breath and reassess the value of the stock, with price staying in a very consistent range. 

Often, this low volume period is an indication of a continuation pattern in formation, and new buyers may eventually swarm to the stock, with the increase in volume causing the bullish trend to start anew, leading to consistent price increases.

How Volume Influences Bearish Trends


In stock market jargon, bearish refers to “selling,” or the idea that investors are pessimistic about the future prospects of a stock. This can also be referred to as “short.”

During a bearish trend, there is a high volume of selling taking place with the stock, with prices dropping lower and lower as shareholders scramble to get what they can for their shares. The lower volume will lead to a stabilization in price, at which point traders take some time to reassess the value of the stock. Continued high volume selling would see the bearish trend pick back up, leading to increasingly lower prices, while increased buying volume would reverse the bearish trend and be accompanied by higher share prices.


Volume and Penny Stocks

Generally, anything trading for under $1 per share is considered a penny stock. These stocks lose their place on major stock exchanges and are closely monitored by the securities and exchange commissions.

Due to their low price, investors can scoop up huge volumes of shares, sometimes in the millions. This kind of volume in a single transaction can significantly sway the price of a stock. If it is determined that the trading of penny stocks is being made to artificially influence the price for the benefit of another related party, those involved can face severe criminal penalties.

Conclusion

High volume buying will lead to increases in stock prices, while high volume selling will lead to decreases in stock prices. Periods of low volume will lead to a stabilization in price.

In order to make money day trading, investors must look for technical patterns confirmed by volume to get an idea of where a stock’s price may be headed. In addition, he or she will want to pay attention to the news, public opinion, and/or social media to see if there is anything groundbreaking that may lead to a large volume of shares changing hands.

Skylar Hammond is a writer for True Trader who specializes in topics such as stock trading, personal finance, and forex. He focuses on helping beginners and experts alike learn more about the market and improve their trading skills.