Trading Volume Essay ⋆ Business Essay Examples ⋆ EssayEmpire

Trading volume is the number of shares transacted in a security over a given period of time, usually a day. It is essentially the quantity of the security traded in the market and can be calculated for stocks, futures, options, bonds, foreign exchange, and commodities. As there is a seller for every buyer, one way to think of trading volume, at least for stock, is as half the number of shares transacted: if person A sells 100 shares to person B, the volume is 100 shares. However, some markets measure volume differently. For example, the NASDAQ counts each side of the trade and so the volume would be 200 shares. We can also sum the volume of individual securities in a market and obtain a measure of overall market volume. The latter provides a useful measure of quantity analogous to a market price index.

An Important Indicator

Along with the price of a security, volume represents one of the most basic and important indicators of activity, for the security itself and the market as a whole. The trading volume gives investors a sense of the amount of activity in the security or the market during the day, and may provide signals to their future course. For example, increasing volume can be an indication that prices in the market will increase in the future. Simultaneous increases in prices and volume are an even more bullish (positive or buy) signal. On the other hand, decreasing volume is an indication that prices may fall in the future. A combination of falling prices and volume is then a bearish (negative or sell) signal for future prices.

Volume in financial markets tends to grow as the number of market participants (buyers and sellers) increases with the size of the market (for stocks, measured in terms of capitalization). For example, the New York Stock Exchange (NYSE) had a daily share volume of 1 million in 1886 and this had grown to 10 million in 1929, 500 million in 1987, and 5 billion in 2007: the highest volume day was 5,799,792,281 shares on August 16, 2007. Large trading volumes also tend to coincide with daily market record highs and lows. This need not be the case for an individual security: if the liquidity of a security is low, very large changes in price require only small volumes. Volume is also used to measure the share of trades conducted in different markets. For example, NYSE-listed securities are traded on the NYSE and in other markets (like NASDAQ), and their respective shares of trading volume can be used to identify which of these markets are relatively more important.

Technical Analysis Of Volume

One area where volume is enthusiastically used is in the area of technical analysis. This is a financial markets technique that claims the ability to forecast the future direction of security prices through the study of past market data, including price and volume. Technical analysis considers only the actual price behavior of the market or security, on the assumption that the price reflects all relevant factors before an investor becomes aware of these through other channels. This contradicts the weak form of the efficient market hypothesis that states that current market prices incorporate all historical market information.

Technical analysts employ a variety of models and trading rules based on volume and these include on balance volume, price and volume trend, and money flow. On-balance (or cumulative) volume relates the price and volume in the stock market. Volume on an up day (where the closing price is higher than the previous close) is added and volume on a down day is subtracted. This can be applied to individual stocks based upon their daily up or down close, or the market as a whole using breadth of market data. Generally, on-balance volume is used to confirm price moves. The idea is that volume is higher on days where the price move is in the dominant direction, for example, in a strong uptrend there is more volume on up days than down days. Accordingly, when prices increase, on-balance volume should also increase.

Price And Volume Trend

Price and volume trend is another indicator used to relate price and volume in the stock market. It is based on a running total volume, with volume added according to the percentage change in closing price over the previous close. Price and volume trend is interpreted such that volume is higher on days with a price move in the dominant direction, for example, in a strong uptrend there is more volume on up days than on down days. So when prices increase, price and volume trend should also increase, otherwise a weak market movement is indicated.

Money flow in technical analysis is the typical price (high price plus low price plus closing price divided by three) multiplied by volume: this provides an approximation of the dollar value of the day’s trading. These are divided into positive (negative) money flows where the typical price is higher (lower) than the previous day’s price and then totaled over a given period: unchanged prices are discarded. Dividing positive money flow (enthusiastic buyers) by negative money flow (enthusiastic sellers) forms a money ratio, while adding one to the money ratio, dividing it into 100 and subtracting it from 100 forms the money flow index. Generally, high (low) values of the money flow index indicate a stock is overbought (oversold).

More recently, volume has been used in statistical models that attempt to explain the level and volatility of price movements. Here, volume serves as a measure of information flow that affects the price of the security. The findings generally indicate that volume is a good proxy of information flow in the market.

Bibliography:

Mary Buffett and David Clark, Warren Buffet and the Interpretation of Financial Statements: The Search for the Company with a Durable Competitive Edge (Simon & Schuster, 2008);
John L. Knight and S. Satchell, Forecasting Volatility in the Financial Markets (Butterworth-Heinemann, 2007);
Owen Lamont and Andrea Frazzini, The Earnings Announcement Premium and Trading Volume (National Bureau of Economic Research, 2007);
Alexander von Nandelstadh, Analysts’ Accuracy of Estimation and the Relative Trading Volume (Swedish School of Economics and Business Administration, 2002);
Willain Pascal, Value in Time: Better Trading through Effective Volume (Wiley, 2008);
Mei Qiu and John Pinfold, Price and Trading Volume Reactions to Index Constitution Changes: The Australian Evidence (Massey University, 2005);
Ronald D. Ripple and Imad A. Moosa, The Effect of Maturity, Trading Volume, and Open Interest on Crude Oil Futures Price Ranged-Based Volatility (Department of Economics, Macquarie University, 2007);
Priit Sander, Tax Heterogeneity and Trading Volume around the Ex-Dividend Day: Estonian Evidence (Tartu University Press, 2007).

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